Cash Flow Exposure Research Articles

Investigating sources of unanticipated exposure in industry stock returns

This paper investigates the sources of both foreign exchange rate and interest rate exposure of industry level portfolios in the G7, decomposing exposure into cash flow and discount rate effects. Initial examination of the degree of exposure on industry returns produces results consistent with the prior literature: that there is little evidence of exchange rate exposure in most industries – the exchange rate exposure puzzle. However, rather than relying solely on the sensitivity of industry returns, we examine the cash flow sensitivity to foreign exchange exposure, of primary interest to firm managers. Critically, decomposing the exposure into cash flow and discount rate components unlocks the exact extent and nature of exposure. Our results show industries have significant cash flow and discount rate exposures. These exposures increase with the level of trade openness and the spread between permanent cash flow exposure and transitory discount rate exposure widens.

Foreign exchange exposure of US tourism-related firms

To date, literature on foreign exchange risk has paid a particular attention to multinationals in trade-related industries. The tourism sector is also sensitive to the exchange rates between travelers’ home countries and their destinations. Suspecting that the exposure of domestic tourism-related firms to foreign exchange risk results from price elasticity of demand, the current study tested the cash flow exposure of sample firms, accounting for nonlinearity, asymmetry, and lagged effects. As a result, a significant percentage (78%) of domestic tourism-related firms was found to have significant foreign exchange exposure. This study also found that exchange rate exposure for tourism-related firms was nonlinear, asymmetric, and lagged. The evidence implied that several tourism-related firms are passive regarding their exposure and may face financial burdens caused by demand fluctuations. Implications and suggestions are presented along with the findings of the study.

Long Run and the Temporal Aggregation of Risks

The long-run risk model introduced by R.Bansal and A.Yaron (2004) assumes the existence of a small predictable component in consumption growth and an elasticity of intertemporal substitution of the representative agent larger than one for the substitution effect to dominate the income one. Previous tests fail to detect predictability in mean consumption growth fluctuations and the estimated value for the elasticity of intertemporal substitution is smaller than one. We argue that these apparent inconsistencies are due to a severe error-in-variables problem generated by the heterogeneity in the persistence levels of shocks to consumption growth. In this paper the original long run risk model is extended introducing a novel persistence based decomposition which can be considered as a refined permanent-transitory decomposition where the transitory shock is further split into orthogonal components. This new decomposition provides an effective method to represent a time series as a linear combination of innovations classified by their level of persistence and their time of arrival. Correspondingly the relations between equity return variations, cash flow risk and persistent fluctuations in the consumption mean are disaggregated across different levels of persistence and the complete term structure of risk return tradeoffs is computed. Quite remarkably, the empirical tests performed within this extended setup find evidence of consumption growth predictability, produce sizeable estimated for the equity premia and explain the value premium as an effect of the differential exposure of cash flows to consumption risk.

Investigating Sources of Unanticipated Exposure in Industry Stock Returns

This paper investigates the sources of both foreign exchange rate and interest rate exposure of industry level portfolios in the G7, decomposing exposure into cash flow and discount rate effects. Initial examination of the degree of exposure on industry returns produces results consistent with the prior literature: that there is little evidence of exchange rate exposure in most industries - the exchange rate exposure puzzle. However, rather than relying solely on the sensitivity of industry returns, we examine the cash flow sensitivity to foreign exchange exposure, of primary interest to firm managers. Critically, decomposing the exposure into cash flow and discount rate components unlocks the exact extent and nature of exposure. Our results show industries have significant cash flow and discount rate exposures. These exposures increase with the level of trade openness and the spread between permanent cash flow exposure and transitory discount rate exposure widens.

Corporate cash flow and stock price exposures to foreign exchange rate risk

This paper estimates the foreign exchange rate exposure of 6917 U.S. nonfinancial firms on the basis of stock prices and corporate cash flows. The results show that several firms are significantly exposed to at least one of the foreign exchange rates Canadian Dollar, Japanese Yen and Euro, and significant exposures are more frequent at longer horizons. The percentage of firms for which stock price and earnings exposures are significantly different is relatively low, though it increases with time horizon. Overall, the impact of exchange rate risk on stock prices and cash flows is similar and determined by a related set of economic factors.

Corporate Cash Flow and Stock Price Exposures to Foreign Exchange Rate Risk

This paper estimates the foreign exchange rate exposure of 6,917 U.S. nonfinancial firms on the basis of stock prices and corporate cash flows. The results show that several firms are significantly exposed to at least one of the foreign exchange rates Canadian Dollar, Japanese Yen and Euro, and significant exposures are more frequent at longer horizons. The percentage of firms for which stock price and earnings exposures are significantly different is relatively low, though it increases with time horizon. Overall, the impact of exchange rate risk on stock prices and cash flows is similar and determined by a related set of economic factors.

The management of exchange‐rate risk: A case from the manufacturing industry

AbstractThis article looks into the management of exchange rate risk at a U.K.‐listed company. The focus is particularly on the firm's operating exchange risk, for which it uses a synthesis of three different risk management approaches. These include the use of long‐term financial hedging instruments, operational adjustments based on real options theory, and the currency denomination of debt. Practice at the case company is unique, in that the former approach has been considered inappropriate by the theoretical literature and the latter is seldom used to manage firms' real cash flow exposures. In general, it has important implications for multinationals, especially with reference to the use of operational adjustments and the currency denomination of debt. © 2004 Wiley Periodicals, Inc.

Scale economies in hedging foreign exchange cash flow exposures

This study finds that a sample of U.S.-based multinational corporations (MNCs) with heavy involvement in Europe is less frequently exposed to European currency risk than to non-European currency risk. Furthermore, 60% of the time, the MNCs without European exposure are found to have non-European exposure. These results are likely due to scale economies in foreign exchange exposure hedging that recently has been suggested in the literature. To the extent that economies of scale in hedging exist, it is likely that MNCs can achieve these economies in areas where they conduct substantial business activities, thus are more able to justify the necessary hedging programs.

Interpreting Risk Premia Across Size, Value, and Industry Portfolios

In this paper, we model cash flow and consumption growth rates as a vector-autoregression (VAR), from which we measure the response of cash flow growth to consumption shocks. As the appropriate cash flow proxy is not unambiguous, nor likely to be measured without error, we consider three alternatives for portfolio cash flows: cash dividends, dividends plus repurchases and corporate earnings. We find that the long-run exposure of cash flows to aggregate consumption risk can justify a significant degree of the observed variation in risk premia across size, book-to-market, and industry sorted portfolios. Also, our economic model highlights the reasons for the failure of the market beta to justify the cross-section of risk premia. Most importantly, our results indicate that measured diferences in the long-run exposures of cash flows to aggregate economic fluctuations as captured by aggregate consumption movements contain very valuable information regarding diferences in risk premia. In all, our results indicate that the size, book-to-market and industry spreads are not puzzling from the perspective of economic models.

Firms, do you know your currency risk exposure? Survey results

This paper surveys the currency risk management practices of Swiss industrial corporations. We find that industrials are unable to quantify their currency risk exposure and investigate possible reasons. One possibility is that firms do not think that they need to know because they use on-balance-sheet instruments to protect themselves before and after currency rates reach troublesome levels. This is puzzling because performing a rough estimate of at least the exposure of cash flows is not prohibitive and could be valuable. Another puzzling finding is that firms use currency derivatives to hedge/insure individual short-term transactions, without apparently trying to estimate aggregate transaction exposure.

Firms, Do You Know Your Currency Risk Exposure? Survey Results

This paper surveys the currency risk management practices of Swiss industrial corporations. We find that industrials do not quantify their currency risk exposure and investigate possible reasons. One possibility is that firms do not think they need to know because they use on-balance-sheet instruments to protect themselves before and after currency rates reach troublesome levels. This is puzzling because a rough estimate of at least cash flow exposure is not a prohibitive task and could be helpful. It is also puzzling that firms use currency derivatives to hedge/insure individual short-term transactions, without apparently trying to estimate aggregate transaction exposure.

Foreign Exchange Risk Management — The Paradox

Two principal forms of cash flow exposure to real exchange rate changes have been identified in the literature, namely transaction exposure and economic exposure. A number of surveys carried out over the last two decades have reported that managers attach more importance to managing transaction exposure than to managing economic exposure. The theoretical literature, on the rare occasions when the issue has been addressed, indicates that while both forms of exposure are linked, economic exposure should be a more significant exposure than transaction exposure for corporations. This paper examines the available evidence from empirical surveys of foreign exchange risk and its management in order to confirm or reject theoretical predictions and the truth of this paradox, and in case of the confirmation of the paradox to suggest a rationale for its existence. In the event the evidence reviewed in this paper confirms the paradox and suggests alternative explanations for its existence.

Measuring macroeconomic exposure: The case of Volvo Cars*

AbstractVolvo Cars' economic exposure to exchange rates and other macroeconomic variables is estimated using quarterly cash flows as the firm's target variable. We discuss first several issues relating to management's view of the macroeconomic environment, as well as the firm's objective and structure. These issues must be addressed before multiple regression analysis can be implemented with the purpose of estimating exposures. the use of cash flow exposure coefficients for evaluating exposure and choosing currency denomination of liabilities is illustrated, and an out‐of‐sample analysis of the estimated exposure coefficients is carried out.

Cash Flow versus Accounting Exposures to Currency Risk

Differences in exchange rates, currency valuations, and various other complexities require careful fiscal management for international corporations. Managers must clearly define their corporate objectives in order to effectively manage exposure to currency risk. The author discusses specific approaches to such management, including an accounting approach and a cash-flow approach. He cites the example of a fictional multinational firm that deals in several nations and their currencies.