TYPES OF RISK EXPOSURE

There are mainly three types of foreign exchange exposures

• Translation exposure
• Transaction exposure
• Economic exposure

· TRANSLATION EXPOSURE (TRANSFORMATION)

Accounting exposure, also known as translation exposure, it is the level to which a firm’s foreign currency denominated financial statements is affected by exchange rate changes. All financial statements of a foreign subsidiary have to be translated into the home currency for the purpose of finalizing the accounts or to compare financial results for any given period.

(If a firm has subsidiaries in many countries, the fluctuations in exchange rate will make the assets valuation different in different periods. The changes in asset valuation due to fluctuations in exchange rate will affect the group’s asset, capital structure ratios, profitability ratios, solvency ratios etc.)

As investors all over the world are interested in home currency values, the foreign currency balance sheet & income statement are restated in the parent country’s reporting currency.

FOR EXAMPLE: foreign affiliates of US companies must restate the franc, sterling or mark statements into US $ so that the foreign values can be added to the parent US $ denominated balance sheet & income statement. This process is called “translation”.