Translation risk definition

What is Translation Risk?

Translation risk is the risk of incurring losses when there are adverse changes in exchange rates. Translation risk can arise in the following circumstances:

  • When you pay a supplier in another currency. If the payment is scheduled for a future date, and if the exchange rate for this currency increases in the interim, then you will sustain a loss on the currency translation.

  • When you receive a payment in a different currency. If the payment is scheduled for a future date, and if the exchange rate for this currency declines in the interim, then you will sustain a loss on the currency translation.

  • When you hold assets denominated in a foreign currency. If you eventually liquidate these assets and then convert the proceeds into your home currency, this will result in a currency translation loss if the exchange rate for the currency declines in the interim.

Translation risk can be a major concern for organizations with extensive international operations. A firm that wants to mitigate its translation risk can engage in hedging transactions. Conversely, a firm that experiences a small amount of translation risk may elect to not manage the risk, resulting in modest gains or losses from its foreign currency transactions.

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