Exchange rate exposure

Of course the impact of the exchange rate on firms’ required rates of return can be exam- ined by estimating risk premium relative to an exposure over a sample period, where the currency movements are distributed something close to the unconditional distribution. 5 A series of papers have used standard asset pricing models to determine whether exposure to exchange rate risk has an identifiable risk premium. The results of most of these studies, however, do not present clear evi- dence for the existence of an unconditional premium for exchange rate exposure. While some stud- ies identify a significant unconditional return premium for currency exposure in the United States (Aretz et al. 2005; Kolari, Moorman and Sorescu, 2005; Dukas, Fatemi and Tavakkol, 1996; Choi, Elyasiani, and Kopecky, 1992; Dominguez, 1987) or Japan (He and Ng, 1998), other studies find no such evidence for the United States (Jorion, 1991), Japan (Brown and Otsuki, 1990; Hamao, 1988) and Australia (Loudon, 1993). A study of industry portfolios in the United States, Germany, Japan, and the U.K. yields a significant return premium for exchange rate exposure only in the first country when using 2- and 3-factor models (Prasad and Rajan, 1995). Similarly, a study that also includes the Canadian stock market finds only low significance of a return premium for the bearing of exchange rate exposure (Gupta and Finnerty, 1992).

This study investigates the exchange rate exposure of Chinese firms at the industry and firm level based on the conventional capital asset pricing model (CAPM) framework. At the industry level, the dynamic conditional correlation MGARCH (DCC MGARCH) estimates demonstrate that the market model and three-factor model are appropriate for exposure measurements, and industry returns are more likely to be exposed to unanticipated changes in the real exchange rate and the trade-weighted effective exchange rate, particularly for manufacturing industries. At the firm level, although the seemingly unrelated regression (SUR) estimates vary across markets, it is apparent that there is a relationship between firm size and exposure effects, which also show that lagged exchange rate changes have significant exposure effects on firm returns. This study finally suggests that non-financial firms should set up special commissions to hedge currency risks of their future cash flows.

flexibility necessary to be able to respond operationally to exchange rate changes quickly (real options), it likely will take the firm some time to make the desired operational changes. While changing suppliers may take only a quarter or two, altering the mix of outputs produced by the firm or moving the location of production may take several years. Nevertheless, the ability of the firm to make these sorts of operational changes in response to an exchange rate change dampen the market’s perception of the exposure by reducing the impact of the exchange rate change on profits in the future, leaving just the impact on profits in the short-run. Therefore, operational hedging is a plausible explanation for finding lower stock price exposure than might be expected based upon the degree of international activity. While foreign operations are likely to reduce the exchange rate exposure in principle, the effect will be stronger for multinational corporations with subsidiaries spread across many countries (breadth) as opposed to a high concentration of foreign operations in a few countries (depth). Table 2 summarizes evidence on important patterns observed in the cross-section of exchange rate exposures. The existing empirical evidence sug- gests that corporations with greater breadth have lower exchange rate exposures, while those with greater depth are more exposed (Pantzalis et al., 2001).

The results of the specifications with individual currencies reveal significant exposures of the op- erating cash flow of VEBA to the British Pound, the Japanese Yen and the U.S. Dollar. Moreover, the signs of the coefficients are generally as predicted. In particular, the exposure coefficients for the British Pound, the Norwegian Krone, and the Swedish Krona are positive, which identifies these as export mar- kets, e.g. for VEBA’s electricity. The negative sign on the Japanese Yen and the U.S. Dollar suggests these as currencies of denomination of input markets and/or competitive effects. In fact, VEBA sources electronics in Japan, while its extensive petrochemical operations and loss-making U.S. operations imply adverse effects of the strengthening U.S. Dollar. The fact that operating cash flows exhibit significant foreign exchange rate exposures indicates that operational hedging and pass-through are not sufficient to eliminate foreign exchange rate exposure. This appears reasonable given that foreign business operations are costly to establish (and to unwind), that they are likely motivated by considerations other than just foreign exchange risk management, and that the nature of product market competition limits the ability to pass exchange rate effects on to customers.

pass-through, namely the impact on prices; we study the impact on stock prices and profits, i.e. exposure. Our 1x1 model closely relates to those of Bodnar et al., and Dekle. Bodnar et al. They estimate a two- equation price and quantity competition differentiated model for eight Japanese export industries during 1986- 1995 examining if the relation between exchange rate exposure and pass-through as derived in their model is consistent with actual behavior. However, we think that the type of goods used to study exposure plays a key role and the consumable products are more appropriate to estimate a simple static profit maximizing model. For this reason our sample does not include durable goods and hence it is free from any dynamic interaction effects. Using a profit maximizing model, Dekle studies automobile, steel, radio-and television-receiver and musical instrument industries. As expected, in markets where domestic and export goods are close substitutes, exporters are hesitant to pass on price increases when their home currency appreciates. Dekle looks at the impact of foreign competition on exposure in a Cournot setting and tests whether exporters collude in foreign markets.

The core concept of this study goes back to the classical study of agency theory. The executives are the agents taking care of the business on behalf of the shareholders. If the executives are well compensated then it is expected that the executives should take good care of the business. Taking good care of business ultimately translates into maximizing share holders’ wealth. In an effort to align the wellbeing of share holders’ wealth with executives’ wealth, stock options are given to the executives. When the stock options given to an executive become vested or exercisable but the executive doesn’t exercise it, his wealth becomes tied to the value of stock. According to Ross (2004) this makes the executive like an equity holder instead of a debt holder. And as an equity holder an executive will prefer to take higher risk because it will yield higher expected return as opposed to a debt holder who would prefer low risk and low return. Among a lot of other risk that a business needs to manage, foreign exchange rate exposure is a critical one for

systematic errors in estimating the change in a firm’s value in response to exchange rate fluctuations. They find that abnormal returns are related to lagged changes in the dollar as opposed to instantaneous changes. Shin and Soenen (1999) and Makar and Huffman (2001) also report supportive evidence for this ‘lagged response’ explanation. However, there is a growing body of research that argues that the observed insignificant exposures (mostly short term) are evidences of firm having successfully managed their exposures. Allayannis and Ofek (2001) report that exchange rate exposure is significantly reduced via the use of foreign currency derivatives. Crabb (2002) also lends support to this conception by concluding that hedging activities partially lead to the failure of previous cross sectional research to identify exchange rate exposure.

Li, 2002; Deng and Shen, 2008; Zhao, 2010). While investors prefer to invest in individual industries with higher returns but fewer risks, these industries are subject to exchange rate changes, which adds an additional source of risk. Taking into consideration this situation, studying asymmetric exchange rate exposure at the industry level could provide new insight into systematic risks for investors. There is a voluminous literature on the relationship between exchange rate changes and stock prices. We can group this into three main clusters. First, a large volume of studies investigate the spillover effects of exchange rate movements on stock prices and vice versa (Granger et al., 2000; Nieh and Lee, 2002; Homma et al., 2005; Walid et al., 2011). 4 These studies aim to explore the causal relationship between currency markets and stock markets at the market level. Second, some studies have investigated the asymmetric exchange rate spillovers on stock prices (Apergis and Rezitis, 2001; Reyes, 2001; Chkili et al., 2012). Most of them carry out the examination of asymmetric volatility spillovers using a GARCH model. Third, an increasing number of studies examine the exchange rate exposure of firm value, building upon the conventional capital asset pricing model (CAPM) framework (Miller and Reuer, 1998; Dominguez and Tesar, 2001; Bartram, 2004; Dominguez and Tesar, 2006; Chue and Cook, 2008). These researchers test the asymmetric effects of exchange rate movements on stock returns, which are similar to our study but differ in their econometric modelling. Most of them used the linear regression approach to estimate exchange rate risks, without distinguishing between short run and long run effects, while our study estimates the exposure effect using the nonlinear autoregressive distributed lag approach. There is some literature on the asymmetric effects of exchange rate changes specifically on the Chinese stock market (Yeh and Lee, 2001; Miao et al., 2013), but these studies did not investigate the long run and short run asymmetries of exchange rate exposure and some industries were commonly excluded from their samples, such as non-exporting and financial industries.

The stock market and financial data of XTEKS firms between 2005-2011 is used in the study. Firstly, GARCH analysis is used to document the exchange rate exposure of sample firms between these years. Jorion (1990)’s model, which regresses changes in exchange rates and market return against the stock returns, is widely used in the literature. However, as Agyei-Ampomah et al. (2012) suggest, the coefficient of the variable in Jorion(1990)’s model which represents the changes in exchange rates, measure the exposure over and above that of the market portfolio. So, in our study, orthogonalized market return is used in the Jorion (1990)’s model to measure the total exposure, following Agyei-Ampomah et al. (2012). After finding out the exposure of sample firms to changes in US Dollars and Euro, the firms are grouped according to their exposure. Then, t-tests are applied to see if there are significant differences between firms which have no exposure and which are significantly exposed, in terms of firm-specific characteristics such as size, share of foreign assets and foreign sales, and currency positions. As a result, we found that approximately 40% of firms in the sample were affected by the fluctuations in values of both US Dollar and Euro in each year between 2005-2011. For Dollar exposure, we found that there were no statistically significant differences between exposed and unexposed firms in terms of the share of foreign sales and foreign assets, currency position and firm size. However in terms of Euro exposure, the results of t-tests showed that firms that were exposed significantly to Euro have higher percentages of foreign sales over total sales, higher foreign assets over foreign liabilities and also higher foreign assets over foreign liabilities ratio.

Jorion (1990) examined the exposure of US multinationals to foreign currency risk through simple OLS regression analysis. He uses monthly data on stock returns and trade-weighted exchange rate. His sample period starts from January 1974 and ends in December 1987. He also considers three subperiods, 1971-75, 1976-80, and 1981-87. His results provided evidence that the relationship between stock returns and trade-weighted exchange rate differs systematically across multinationals. He also found that the co- movements between stock returns and the value of the dollar to be positively related to the percentage of foreign operations of US multinationals. Finally, his analysis points out firms with no foreign operations exhibit in practice little measurable difference in exchange-rate exposure.

Exchange rate exposure that measures the sensitivity of firm’s value to exchange rate changes is a crucial issue in financial management, because unexpected exchange rate changes may affect a firm’s pricing decisions, future cash flows, and firm valuation as well as risk management. Over the past three decades, firms and industries that were once national have become more global resulting in large increases in international activity. This in turn makes exchange rate exposure management a key component of corporate strategy. The challenges for investors, creditors, and managers alike is then accurately access the size and direction of this exposure, since quite basically the problem must be accessed before it can be managed. Consequently, many theoretical models and empirical studies on the exchange rate exposure on firm’s or industrial’s valuation in both industrial and developing countries have been published over the last decades. Koutmos and Martin (2003), Bartram, Dufey, and Frenkel (2005), and Muller and Verschoor (2006) provide reviews.

We examine exchange-rate exposure in an international Bertrand model of differentiated goods using a “Rule of Three” (RoT) market structure that allows both within and between countries competition. We construct two versions of our model, a static and a dynamic one. In the latter, we explore how the intertemporal effects of exchange rates on the optimal prices of a firm’s domestic and international rivals will affect a firm’s long-run exposure in relation to its short-run exposure. We find that in the static version, the addition of a domestic competitor increases the firm’s exposure, while the effect on its foreign competitor is ambiguous. In the dynamic case, we find that the gap in exposure between the RoT model and the international duopoly case is larger in the long run than in the short run for the company facing a domestic rival, while the exposure for that firm can be either smaller or larger in the long run relative to the short run. Finally, the firm that remains a monopolist in its domestic market has a smaller exposure in the long run as compared to the short run.

The primary goal of our analysis is to better understand empirical facts, but to properly account for all relevant factors it is necessary to have a specific model of exposure. Despite the encouraging results presented in the previous section, the calculated Residual Exposure still (i) overestimates exposures on average and (ii) predicts a wider range of exposures than actually observed among automakers. One potential explanation for these results is our use of a relatively simple model as an illustrative example. Specifically, the model is for a monopolist with exogenously specified cash flows. In the preceding analysis, we analyze the effect of product market competition on foreign exchange rate exposure with the naive assumption that the gross profit margin is a sufficient statistic for describing a firm’s level of overall competitiveness. In this section, we present a more realistic model of the foreign exchange rate exposure of a global firm in a globally competitive market based on the results of Bodnar, Dumas, and Marston (2002).

It is widely believed that exchange rate exposure can affect the value of the multinationals. More specifically, an increase in home currency value decreases multinationals value by decreasing foreign currency dominated cash flows and assets, and vice-versa. However, empirical results found on this issue are contradictory. This study investigates this contradictory issue by analyzing performance of 103 United Kingdom based multinationals from FTSE-250 from the time period of January 2005 to July 2010. This study is considering stock return as an indicator of firm value and using two factor regression model proposed by Jorion (1990). The study has not found any significant relationship between pound sterling value and UK multinationals value. Regression analysis has shown that approximately 85% UK multinationals do not have any significant relationship between pound sterling fluctuation and firm value. Only approximately 6% multinationals with significant t-value and negative beta coefficient accept the theory that depreciation in pound sterling value increases firms’ value. Around 9% multinationals with significant t-value and positive beta coefficient for exchange rate contradict with the theory.

the rise in oil prices as considered as a good sign increases earnings from exports. Economic theories indicate that depreciation of exchange rate tends to expand exports and reduce imports, while the appreciation of exchange rate would discourage exports and encourage imports. Thus, exchange rate depreciation leads to income transfer from importing countries to exporting countries through a shift in the terms of trade, and this affects the economic growth of both importing and exporting nations. Gross domestic product is one of the important barometers to measure the economic growth. Exchange rate volatility and fluctuation in oil prices adversely affects economic growth. Various factors affecting exchange rate are inflation, interest rate, exports, imports, foreign debt, industrial growth and foreign direct investment. Exchange rate and oil prices have a significant impact on the growth of the economy. So, the research problem is to find out ―the macroeconomic variables like imports, exports, inflation, interest rate, government consumption expenditure and foreign direct investment have a significant impact on exchange rate and is exchange rate volatility and oil prices shocks has a significant long run relationship with economic growth and what is its short run adjustment mechanism in short run in Russia.‖ The aim of this paper is; to check the long run as well as short run impact of exchange rate and oil prices on economic growth, to identification of growth rate variables that are affected by exchange rate are inflation, export, import, interest rate, foreign direct investment, government consumption expenditure. This paper extend literature in two directions; first it will establish a relationship between oil prices and exchange rate with economic growth, and measures a long run relationship and short run adjustment mechanism in between macroeconomic variables and exchange rate like exports, imports, interest rate, inflation, foreign direct investment and government consumption.

The model offers two firm-level implications about the pattern of foreign currency borrowing and investment across firms that we test in data. First, at the extensive margin, there is selection into foreign currency borrowing, as only firms above a certain productivity threshold optimally choose to borrow in foreign currency. Given the persistence of the productivity shock, more productive firms today are less sensitive to default in the next period for any given level of capital, local and foreign currency debts. This lower default sensitivity allows them to better tolerate the exposure to currency risk (i.e. without significantly increasing their costs of funds) and borrow in foreign currency. There is a productivity level below which the exposure to currency risk increases a firm’s default probability and cost of funds sufficiently such that the optimal decision is to only issue local currency debt. Second, at the intensive margin, higher deviations from the UIP promote foreign currency borrowing, particularly of productive firms with low capital (i.e. firms with high marginal product of capital -MPK). Higher UIP deviations increase the benefit of issuing foreign currency bonds, which allow firms to tolerate higher exposure to currency risk and hold higher levels of foreign debt. Firms with high MPK have higher return to investment and can exploit the relative lower foreign currency rate to increase their investment and reach faster their optimal scale of production. This trade-off between exposure to currency risk and potential growth is the mechanism that drives firms’ foreign currency borrowing decisions.

The highest exposure is observed in case of Hungary and Czechia. Positive tendency can be seen in comparison of pre‑crisis and post‑crisis period. Despite the financial crisis, except the case of Hungary, all markets showed decreased exchange rate exposure in time. In Hungary, higher increased exposure coefficient can be explained by the high ratio of company debt denominated in foreign currency. On the other hand, decreasing of exposure can be due to the using of more sophisticated instruments on the hedging markets and companies can have good resources and strategies to hedge against exchange rate risk. In case of Slovak stock companies can be crucial fact that Slovakia become a member of the Eurozone. In case of the Czech Republic can be results influenced by the interventions on the foreign exchange market provided by the Czech National Bank, which could decrease the uncertainty about Czech koruna’s value development. After the adopting the exchange rate interventions as a standard monetary policy instrument, the exchange rate against Euro as the most important currency was stable, without significant fluctuations. The exchange rate exposure in CZK/EUR operations was almost zero and companies had no reason to hedge their international activities. Therefore, the total currency exposure could decrease.

The specification in equation (2) allows for changes in exchange rate exposure from the period before the deal to the period. In the most simplistic of situations, the change can be summarized as going from no exposure before the deal (because the firm is just operating in the U.S.) to significant exposure after the deal, reflecting the change in cash flows that accompany the acquisition. However, many other situations could arise and other factors come into play. For example, the impact of the deal on the acquirer depends on the characteristics of the target acquired, such as the target’s own exposure to exchange rate risk. Therefore, we estimate equation (1) for the target firms before they are acquired. We report these results as well as characteristics that would affect the post-merger sensitivity of the acquirer in Table 4. Scarcely any of the targets have significant exchange rate exposures (Panel A). In addition, characteristics of the acquirer are relevant. For instance, Panel B indicates that some of the acquiring firms hedge exchange rate risk with derivatives: About a third of the firms use one or more currency derivatives tied to the target country currency after the acquisition. And, nearly two thirds of the acquirers in our sample already have operations in the target country, making it more likely that the acquisition serves to reduce exposure to the target country rather than increase it.

period 1977-1996. According to these researchers, there is a reduction in the residual variance of the regression with the inclusion of the market return in the exposure model specification, which improves the precision of the exchange rate exposure estimates and controls the value-relevant macroeconomic characteristics connected with the rate of exchange. The ability to understand the ensuing exchange rate exposure coefficients is thus improved. The fraction of firms with statistically positive and negative exchange rate contact varies distinctly over diverse horizons according to the results. The fraction of firms with positive exposure coefficients radically outnumbers those with negative exposure coefficients in short horizons. Nevertheless, ahead of the 12-month-return horizon, these researchers note more negative exposure coefficients than positive exposure coefficients, only to see them balance out beyond 24-month-return horizons. Both firm size and foreign sales ratio are vital for clearing up cross-sectional differences in exchange rate exposure, according to the results based on all horizons. The negative correlation of the exchange rate indicates that firms receive higher returns when the dollar depreciates; this suggests consistency with economic intuition and leads to increases in the streams of the value of foreign cash flow due to dollar depreciations, that is true according to theories in economics because a decrease in the value of the dollar enhances the worth of foreign cash inflows.

Foreign exchange is among the most important risks facing most economic agents, whether they are corporations, institutional investors, or households. In recent times, the volatility of these rates has increased substantially and, as a result, agents have a greater need to hedge against these risks. In today’s business environment, firms find it necessary to hedge the exchange rate risk, which has a big impact in their earnings. This risk affects not only firms engaged in international business but even those operating only in their local markets. Albanian businesses face a high rate of exchange rate risk due to strong business relationships with neighbor countries and broader. Hedging this risk is difficult because in a developing country like Albania, currency derivative market does not exist. The nonfunctioning of Tirana stock exchange, the fact that commercial banks still do not offer forward contract widely, and the lack of financial knowledge among businesses’ representatives are among the reasons that makes hedging so difficult in our country.This paper investigates to what extend Albanian businesses face exchange rate risk, and how these businesses hedge it. We have considered a case study from an Albanian firm and found out the ways they protect their earnings from this risk. One concerning finding is that Albanian firms do not hedge financially the exchange rate exposure, even though they have a large degree of exposure. At the end we conclude by developing a framework for currency hedging to be applied from these firms in order to reduce their currency exposure.