Hedging Translation Exposure

Exchange rates used in translating the financial statements of foreign subsidiaries may depreciate or appreciate substantially over a given accounting period. Short of net zero exposures on a currency-by-currency basis, such fluctuations in exchange rates will generally result in considerable exchange losses (gains) that will clearly play havoc with what might otherwise be a smooth income stream from foreign operations. Translation losses will also reduce shareholders’ equity and therefore impact the debt-equity ratio of the firm. As the leverage ratio deteriorates, the firm will find its cost of debt financing increasing and/or its access to financial markets restricted.