Effective FX-Hedge Policy Using Financial Market in Korea

Abstract

Since the global financial crisis, inflows and outflows of foreign capital increased greatly and this resulted in a higher volatility in exchange rates. In addition, many countries introduced quantitative easing in order to overcome the eurozone financial crisis and the global recession. The value of their national currency declined as a consequence and this triggered concerns for a potential global currency war. Korea has constantly been exposed to the risk of foreign exchange market as a small open economy with internationally inconvertible domestic currency. Korea always needs to be prepared for foreign exchange risks that ebb and flow with the conditions of the global economy. In this paper, authors analyzed the current state of Korean companies’ foreign exchange hedging activities to find out whether such hedging is required, by calculating currency exposure of each company. They also examined other cases from around the world to find out the most efficient measure. In general, Korean firms do appear to be vulnerable to foreign exchange volatility. This is because of low awareness among companies regarding foreign exchange risk management and the fact that there are not enough derivatives that allow firms to hedge foreign exchange risks via financial markets. Also, there is the companies’ lack of understanding about foreign exchange risk management methods. The fear of derivatives as a result of the KIKO affair keeps the companies from financial market as well. The foreign exchange risk insurance, which is the most frequently used exchange risk hedging product in Korea, is provided exclusively by the Korea Trade Insurance Corporation (Ksure). However, it does not fully meet the consumers’ demands and was even taken off the market in times of crisis.