Currency translation risk

Currency Translation Risk is possibility of adjusting the company's financial status (assets,
liabilities, equity) due to adjustments in the exchange rate, which is typically seen when
recording the combined financial results of several companies trading in domestic currency
overseas. The impact is primarily on multinational corporations that intentionally operate in
international transactions because of their client and supplier base. In this situation, translation
risk is just like a continuing phenomenon that must be reported in the financial statements each
year. This also impacts businesses that have foreign currency reserves, and same need to be
recognized or announced in the domestic currency. Often this is a one-time occurrence and
correct accounting policies ought to be followed or it may contribute to legal issues.

Since currency fluctuations are tough to predict, the possibility of translation may be volatile,
rendering monitoring more difficult and thus being closely supervised by regulatory authorities.
Translation risk is unique from the transaction risk due to the risk of currency fluctuations which
affects the cash flow of the company. Translation risk presents a significant hazard to
international-market companies. This applies particularly to companies operating in emerging or
frontier markets where the political environment is uncertain and the value of the local currency
is vulnerable to fluctuation. Exchange rates will change among quarterly financial statements,
resulting in substantial variances from quarter to quarter between the published figures
(Instefjord, 2005). Often that may trigger fluctuations in the stock price of the firm. Companies
may attempt to reduce such uncertainties by purchasing or hedging currency derivatives via
futures contracts. In fact, a business may require that consumers pay for products and services in
the domicile country of the company's currency. This way, the burden associated with the local
currency fluctuation is not assumed by the client but instead by the consumer who is liable for
having the currency swap before conducting business with the product (Instefjord, 2005).

Let's classify a practical example of the risk of translation and how it affects the companies. Find
a multi-national Starbucks company working in geographies in the UK and the USA. By running
we say in both countries the company has assets and liabilities. Let's say this firm's US office
experiences a $10,000 operational deficit. The UK division, however, makes a net profit of
£8,000 in the same reporting period. Now that the dollar and pound conversion rate is 0.80, the
firm is efficiently making no loss or profit. A company that wants to offset the risk of exchange
can hedge by options or exotic financial instruments in order to reduce the impact of currency
volatility on its figures.