Interactive trilateral foreign exchange exposure: insights from scenario analysis

Abstract

PurposeThe purpose of this paper is to present scenarios of interactive trilateral foreign exchange (FX) exposure, where a company’s exposures to two foreign currencies depend on those currencies’ FX rate with each other.Design/methodology/approachA pro forma analysis of three-way FX rate changes illustrates interactive trilateral FX exposure and generates observations for a multivariate regression estimation of FX exposure coefficients.FindingsThe multivariate regression estimates of FX exposure provide the basis for a useful financial hedging strategy for interactive trilateral FX exposure. Some of the FX exposure estimates have surprising signs and magnitudes.Research limitations/implicationsScenario analysis does not result in a general theory of interactive FX exposure, but the study’s diverse and rich scenarios may provide helpful insights to theoretical and empirical researchers.Practical implicationsThe scenarios relate to many common real-world situations and thus may help managers and educators better understand how to manage FX exposure.Originality/valueThe topic of interactive FX exposure is under-researched and under-covered in contemporary textbooks or the applied finance literature.