Transaction risk and translation risk.

'Transaction Risk' and 'Translation Risk' Transaction Risk: Transaction risk refers to the potential change in the value of a foreign currency denominated transaction due to changes in the exchange rate. Credit purchases and sales as well as borrowing and lending denominated in foreign currencies and uncovered forward contracts are some examples of transaction exposure. Transaction exposure basically covers the following: Rate Risk: It occurs (a) when there is mismatch of maturities and borrowings and (b) In foreign exchange, it results in net exchange positions Credit Risk: A situation when borrower is not in a situation to pay Liquidity Risk: Less chances of receiving payments. Translation Risk: It is also called accounting exposure. It refers to and deals with the probability that the firm may suffer a decrease in assets value due to devaluation of foreign currency even if no foreign exchange transaction has taken place. The risk is particularly relevant for the companies, which have subsidiaries in other countries. Due to translation exposure the values of assets, liabilities, expenses and profits of foreign subsidiaries may change. Two related decision areas are involved in translation exposure management, (a) Managing balance sheet items to minimize the net exposure & (b) Deciding how to hedge against this exposure.