Differentiate translation exposure and transactional exposure in international finance.

• A. Translation exposure arises from actual cash flows in foreign currencies.
• B. Transactional exposure arises from converting foreign subsidiary statements.
• C. Translation exposure arises from converting foreign subsidiary financial statements; transactional exposure arises from actual cash flows in foreign currencies.
• D. Both exposures are the same and have identical effects.

Answer: (C)

The key idea is distinguishing what each exposure affects: accounting reports versus actual cash flows. Translation exposure occurs when you convert a foreign subsidiary’s financial statements into your home currency for consolidation. This affects reported values on the balance sheet and income statement as exchange rates move, but it doesn’t involve settling real cash flows. Transactional exposure, on the other hand, comes from actual transactions in foreign currencies—payments, receipts, or debt service in those currencies—where exchange-rate movements between the transaction date and settlement date change the cash flows and profits.

So the best description is that translation exposure arises from converting foreign subsidiary financial statements, while transactional exposure arises from actual cash flows in foreign currencies. The other statements mix up these concepts or claim they’re the same, which isn’t accurate.