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Risk ManagementSection BRisk ManagementForeign Exchange RiskTranslation Risk

ACCA · Question 29 · Risk Management

Section B - Case 3: LithiumX

Scenario: LithiumX is a cross-border mining company based in the US. It expects to receive €2,000,000 in exactly 3 months from a European client.
Spot exchange rate: €1.1500 - €1.1550 / $1
3-month forward rate: €1.1600 - €1.1640 / $1
US interest rates: 4% borrow, 2% deposit (annual)
Euro interest rates: 5% borrow, 3% deposit (annual)

LithiumX has a subsidiary in Europe. At year-end, the subsidiary's financial statements, denominated in Euros, must be consolidated into LithiumX's US Dollar financial statements.

Question: What type of foreign exchange risk does this consolidation process represent?

Answer options:

A.

Transaction risk

B.

Translation risk

C.

Economic risk

D.

Liquidity risk

How to approach this question

Distinguish between the three types of FX risk: Transaction (short-term cash flows), Translation (accounting consolidation), and Economic (long-term competitive position).

Full Answer

B.Translation risk✓ Correct
Translation risk (also known as accounting risk) occurs when a parent company consolidates the financial statements of a foreign subsidiary. The subsidiary's assets and liabilities must be translated into the parent's home currency. Fluctuations in exchange rates can cause the consolidated net asset value to change, even if no actual cash has been exchanged.

Common mistakes

Confusing translation risk with transaction risk.
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