Question

Compare and contrast how a revaluation of our foreign subsidiary would affect the value of our subsidiary in terms of translation and operating exposure.

Answer 1

Translation exposure is also known as Accounting exposure. When a subsidiary company goes under a revaluation process, it is exposed to exchange rate risk. Suppose, US company has it's subsidiary company in Germany worth 1,000,000. Before, the revaluation exchange rate dolloar-to-euro is 1:1. But, when the revalution takes place the exchange rate is 1:2. It means the net worth of US subsidiary is reduced to $500,000 from $1000,000. If the exchange rate is 2:1. It means the subsidiary's net worth is $2,000,000.  This exposure to exchange rate is known as translation exposure. The tanslation exposure effects the balance sheet of the company. It can be reduced by hedging the transactions through forward contracts and swaps.

Operating exposure means when the future cash flow of the subsidiary effects the present value of cash flow. Future cash flows are exposed to exchange rates and any kind of unexpected change in exchange rate effects the cash flow. Thus, it may effect the present value of cash flows. Sales and expenses, receivables and payables are highly vulnerable to transaction exposure.