ACCA Financial Management (F9) Certification Practice Exam

What type of risk involves potential exchange losses resulting from translating foreign accounting results into the home currency?

1. Translation risk

2. Transaction risk

3. Economic risk

4. Interest rate risk

The correct answer is: Translation risk

Translation risk refers to the potential losses arising from the process of converting foreign currency financial statements into the home currency for the purposes of financial reporting. This risk occurs when there are fluctuations in exchange rates between the time the foreign operations generate their results and when these results are consolidated with the parent company's financial statements. When companies operate in multiple countries, they often have subsidiaries that report their results in their local currencies. To present a single consolidated financial statement, these results must be converted into the home currency. If exchange rates have changed unfavorably during the period, it can lead to a reduction in the reported profits or assets when they are translated. This fluctuation is specifically what translation risk addresses, impacting investors and stakeholders' perception of the company’s performance and financial position. Transaction risk, on the other hand, deals with the impact of exchange rate changes on specific cash flows resulting from transactions denominated in foreign currencies. Economic risk relates to the long-term effect of exchange rate movements on a company's market value and future cash flows. Interest rate risk involves the possibility of losses due to changes in interest rates affecting the cost of borrowing or the value of fixed-income investments. Each of these risks operates in different contexts, but translation risk is directly concerned with the accounting implications of