Managing foreign exchange risk with derivatives in UK non-financial firms

Abstract

This study assesses the effect of derivatives use of large UK non-financial firms in their foreign exchange risk management activity and tests value relevance of FRS 13. Using a sample of FT UK 500 non-financial firms for 1999 when FRS 13 was implemented, we examine the foreign exchange risk exposure of the firm that is engaged in international business activities, and the effect of the use of foreign exchange derivatives on the firm's foreign exchange risk exposure. There is evidence that UK non-financial firms use derivatives to hedge against the risk of unfavorable exchange rate movements and the hedge is effective in reducing firms' risk exposure to varied degrees. The results support value relevance of FRS 13 that numerical disclosure of derivatives use by firms reveals important information to investors and helps firms reduce the cost of capital and increase firm value.