Translation Exposure

The risk that a company's equities, assets, liabilities or income will change in value as a result of exchange rate changes. This occurs when a firm denominates a portion of its equities, assets, liabilities or income in a foreign currency.

For instance, assume the domestic division of a multinational company incurs a net operating loss of $3,000. But at the same time, a foreign subsidiary of the company in Mexico made a profit of 3,000 pesos. At the time, the exchange rate between the dollar and the peso is 1 to 1. So the foreign subsidiary’s profit exactly cancels out the domestic division’s loss.

However, before the parent company consolidates its financial reports, the exchange rate between the dollar and the peso changes. Now 1 unit of peso is only worth $.50. Suddenly the profit of the foreign subsidiary is only worth $1,500 and it no longer cancels out the domestic division’s loss. Now the company as a whole must report a loss. This is an example of translation exposure.