Translation Exposure

Translation exposure is the impact of currency exchange rate changes on the reported consolidated results and balance sheet of a company. Translation exposure is basically concerned with the present measurement of past events. The resulting accounting gains or losses are said to be unrealized they are paper gains and losses but they are still important. Consider a U.S firm with a subsidiary in Mexico. If the value of the Mexican peso depreciates significantly against the dollar this would substantially reduce the dollar value of the firm’s equity reported in its consolidated balance sheet. This would raise the apparent leverage of the firm which could increase the firm’s cost of borrowing and restrict its access to the capital market. Similarly, if a U.S firm has a subsidiary in the European Union and if the value of the euro depreciates rapidly against that of the dollar over a year, this will reduce the dollar value of the euro profit made by the European subsidiary resulting in negative translation exposure. In fact many U.S firms suffered from significant translation exposure in Europe during 2000, precisely because the euro did depreciate rapidly against the dollar.