Foreign Exchange Risk Exposure Research Articles

Asian Foreign Exchange Risk Exposure

This paper examines whether there exists any relationship between individual Asian firms' stock returns and fluctuations in foreign exchange rates. We find that about 25 percent of these firms experienced economically significant exposure effects to the U.S. dollar and 22.5 percent to the Japanese yen for the period January 1993 to January 2003. While there is time-variation in contemporaneous exposure effects at the individual firm level, the overall extent of exposure is not sample dependent; a depreciating (appreciating) Asian currency against foreign currencies has a net negative (positive) impact on Asian stock returns. The extent to which firms are exposed to exchange rate fluctuations varies with return horizons; short-term exposure seems to be relatively well hedged, where considerable evidence of long-term exposure is found. Firms with weak liquidity positions, in terms of high dividend payout ratios, or less profitable firms, tend to have smaller exposures. We also find that highly leveraged firms or firms with a lower quick ratio are more exposed to exchange rate risk.

Export Flexibility And Currency Hedging*

This article studies the behavior of an export‐flexible firm under exchange rate uncertainty. We show that the separation theorem holds if selling exclusively in the domestic market is suboptimal even under the most unfavorable spot exchange rate. Otherwise, the firm's optimal output depends on its preferences and on the underlying uncertainty. We further show that the full‐hedging theorem holds only when the firm always finds it optimal to sell its entire output in the foreign market. Otherwise, export flexibility introduces a convexity into the firm's foreign exchange risk exposure, which calls for the use of currency options for hedging purposes.

Cross-Hedging with Currency Options and Futures

This paper develops an expected utility model of a multinational firm facing exchange rate risk exposure to a foreign currency cash flow. Currency derivative markets do not exist between the domestic and foreign currencies. There are, however, currency futures and options markets between the domestic currency and a third currency to which the firm has access. Since a triangular parity condition holds among these three currencies, the available, yet incomplete, currency futures and options markets still provide a useful avenue for the firm to indirectly hedge against its foreign exchange risk exposure. This paper offers analytical insights into the optimal cross-hedging strategies of the firm. In particular, the results show the optimality of using options in conjunction with futures in the case of currency mismatching, even though cash flows appear to be linear.

Cross-hedging with Currency Options and Futures

This paper develops an expected utility model of a multinational firm facing exchange rate risk exposure to a foreign currency cash flow. Currency derivative markets do not exist between the domestic and foreign currencies. There are, however, currency futures and options markets between the domestic currency and a third currency to which the firm has access. Since a triangular parity condition holds among these three currencies, the available, yet incomplete, currency futures and options markets still provide a useful avenue for the firm to indirectly hedge against its foreign exchange risk exposure. This paper offers analytical insights into the optimal cross-hedging strategies of the firm. In particular, the results show the optimality of using options in conjunction with futures in the case of currency mismatching, even though cash flows appear to be linear.

The Association between SFAS No. 119 Derivatives Disclosures and the Foreign Exchange Risk Exposure of Manufacturing Firms

This study investigates whether the quantitative disclosures about notional amount and fair value of foreign exchange (FX) derivatives, required by Statement of Financial Accounting Standards (SEAS) No. 119 (FASB [1994]) and its predecessors SFAS No. 105 (FASB [1990]) and SFAS No. 107 (FASB [1991]), are associated with the information used by investors to assess the sensitivity of equity returns to currency fluctuations (currency exposure).' Since derivatives are used to alter risk profiles, I choose risk

The U-Shape Autocorrelation Pattern in International Stock Markets

Employing monthly data from twenty stock markets, this paper tests for the international applicability of a U-Shape autocorrelation pattern of stock market returns. It is demonstrated that the U-Shape autocorrelation pattern in stock returns is typical of many stock markets, an observation that may be exploited in an attempt to generate a trading strategy which yields an abnormal return. The paper constructs several trading strategies which differ from one another along three dimensions: the sources of information, the weights set for an international portfolio and hedging strategies of foreign exchange risk exposure. The results clearly indicate that above normal returns can be obtained from past autocorrelation patterns in different markets.

VENTURING ABROAD—SETTING UP OPERATIONS OVERSEAS

This paper provides a brief insight into the fiscal regimes for international exploration and production,covering some of the management problems, mostly from a financial perspective, that are faced in setting up operations overseas.Any move overseas means another set of local regulations to understand and plan for. Difficulties of language, culture and regulatory structure need to be faced. There must be a high level of understanding of local conditions and selection of staff with local knowledge, well trained and honest with the backup of an established system of internal controls and audit.The organisational structure of the tax planning and compliance functions should be considered. Functions controlled by head office will be most effective when operating activities are low. Progressing to a larger scale of activity may demand daily involvement in tax matters and require local experience.Countries impose, to varying degrees, exchange control regulations. These can inhibit the flow of funds back to the parent company, minimising immediate benefits from the project unless there are re-investment opportunities within the country. Restrictions on the repatriation of funds may serve to increase home country borrowing requirements—if the regulations require the conversion of surplus funds to local currency, a foreign exchange risk exposure is created and has to be managed.Wherever the international involvement leads us there is one over-riding aim, to obtain a return on investment commensurate with the risk. Everything else which impinges on that rate of return, whether it relates to tax changes, contract terms or exchange control regulations, must be compensated for or resisted to maintain the rate of return.

Recent Innovations in Interest Rate Risk Management and the Reintermediation of Commercial Banking

0 A dominant theme of commercial banking in the 1980s has been the search for off-balance sheet, feebased income to improve return on equity. As money center and large regional banks recover from the burdens of the international debt and energy loan crises, new product lines are being sought which meet those criteria. One promising line is Interest Rate Risk Management (IRRM). Commercial banks have become market makers in IRRM products such as forward rate agreements and interest rate swaps, caps, collars, and floors. These products are often versions of, and companions to, instruments that are used to manage a firm's foreign exchange risk exposure. The movement toward market making in IRRM products represents a new form of bank intermediation, a form distinct from the classic function of transforming household savings into corporate borrowings. In this new role commercial banks intermediate be-

Hedging in currency futures: A Singapore dollar case study

In recent months the volatility of currency values, especially the changing value of the US Dollar against the Swiss Franc. Deutsche Mark, Japanese Yen and the Singapore Dollar has significantly increased the foreign exchange risk exposure of multinational corporations. This article looks at several different strategies which a corporate treasurer can consider for minimizing his risk exposure. Finally, two different borrowing strategies in the forward market which are based upon local currency (Singapore Dollar) and foreign currency (US Dollar) borrowing are compared. The results show that substantial cost savings can be obtained by selective borrowing.

THE USE OF FOREIGN CURRENCY FUTURES TO REDUCE EXCHANGE RATE RISK

Introduction In a world of increased uncertainty about the future value of exchange rates and increased visibility of foreign exchange gains and losses, it is not surprising that both commercial and financial firms have become more concerned about minimizing foreign exchange risks. Once a company becomes involved in international trade, be it the formation of a foreign subsidiary or simply the import or export of goods, it subsequently becomes subject to foreign exchange risk exposure. Foreign exchange risk exposure can be broken down into three categories for further development; these are real economic exposure, translation exposure, and transaction exposure.