Article Analysis: Foreign Exchange Exposure of Domestic Corporations

This case shows us that apart from transaction, translation and economic exposure to currency risk, firms also have the very real strategic impact on their competitive position from competitive exposure. Apart from GM’s exposure to the yen which is reflected in their financial statements, their competitive position vis-à-vis Japanese manufacturers is affected by a potentially declining yen. This is because a declining yen reduces the Japanese manufacturers’ $ cost, enabling them to pass on some of the benefit to US customers and thus taking some of GM’s market share. This will impact GM’s top and bottom line. However, GM has a difficult decision regarding managing this risk.

Given the nature of its business, Jaguar is faced with three types of exchange rate exposure (1) Transaction, (2) Translation and (3) Economic . Transaction exposures arise whenever the firm commits (or is contractually obligated) to make or receive a payment at a future date denominated in a foreign currency. Translation exposures arise from accounting based changes in consolidated financial statements caused by a change in exchange rates. In this case we primarily focus on the Economic exposure -also known as Operating exposure or Competitive exposure- of Jaguar.

A long-term strategic plan to manage Two Brother Bhd. exchange rate Risk was using operating exposure. It is also called economic exposure, which examine measures the operating exposure arises through unexpected changes in both operating and financing cash flows. The firm’s requires forecasting and analysing all the firm’s future individual transaction exposures together with the future exposure of all the firm’s competitors and potential competitors. To anticipate and influence the effect of unexpected changes in exchange rate on a firm’s future cash flows, management can diversify the firm’s operating and financing base and also change the firm’s operating and financing policies.

What is exchange rate risk? An exchange rate risk refers to exchange rate fluctuations which can affect a firm’s profits and trade. For example, the euro exchange rate was $0.87 in 2002 but risen to $1.28 in 2012, so the cost in dollars increased by 47.1% over the 10 year period. This increase hurts the export of European products to the United States (Brigham & Ehrhardt, 2014). Also, the volatility of exchange rates incrases the uncertainty of the cash flows for a MNC. Because the cash flows are denominated in many different currencies, the dollar equivalent value of the company’s consoilidated cash flows also functuates (Brigham & Ehrhardt,

Foreign exchange risk management can be termed as the dangers taken into account while making any transactions in global financial markets. For example, if the US dollar currency is low and a company wants to sell goods to America, the buyer will pay in US dollar. This variation in

Evidence from statistical tests suggesting a significant impact of foreign exchange gains and losses on profitability corroborates comments from the financial statements of sample companies for this research. However, this evidence is unlike those of Lee and Suh (2012) who argued that “exchange rate changes explain less than 2% of the variation in foreign operations profitability for most industries and the impact of exchange rate changes on profitability is not significant’’. This conclusion was reached after an empirical study involving 11 different industries. The results of this research are also dissimilar to those of Pantzalis et al. (2001) who finds that only 15% of 220 multinational companies in the US evidence exchange rate exposures that are statistically significant. Evidence from these other studies are also similar to those of most studies conducted using multinationals (Bartov and Bodnar 2012; Griffin and Stulz 2001; Muller and Verschoor 2006). The lack of significant exposure as highlighted by these studies have been ascribed to the hedging activities adopted by Multinational companies to reduce the impact of foreign exchange exposure (Allayannis and Ofek 2001; Lee and Suh 2012).

Evidence from studies suggest that firms involved in foreign operations are exposed to foreign exchange risks which can be further classified into the economic exposure, the transactional exposure and the translational exposure (Moyer et al. 2011; Lumby 2001). Arnold (2008) observed that investment decisions and the viability of foreign operations in the long term are affected by both the transaction, translation and economic risks. This is so because entities are affected by variability of

Globalization has made the world a smaller place and the exposure to overseas markets is increasing. In order to last long this competitive environment the companies have to focus on all the aspects to make the maximum profits, which makes it essential for them to manage risk in exchange rate. The graph below shows the volatility of the GBP as compared to INR.

|diversify and protect their assets from the risks of devaluation of their own currencies. It is useful to distinguish |

of measuring a firm’s exchange rate risk exposure, and examines the main advantages and disadvantages of various exchange rate risk

Where P_t is the adjusted spot exchange rate at time t. The descriptive statistics summary of daily logarithmic returns is reported in Table 1. Therefore, assessing the exposure of currency risk was done by reviewing both return and risk profile for data sets.

Mostly foreign currency derivatives are used for hedging foreign exchange rate risk caused by exchange rate adverse fluctuation. This study is aimed to determine different factors that affect the foreign currency derivatives usage. Secondary data of 112 non financial firms, taken from their annual reports and balance sheet analysis issued by State Bank of Pakistan, is used for analysis for the period 2008 to 2013. Mann Whitney U test was used to check differences in characteristics of foreign currency derivatives users and non-users. Results show that users of the foreign currency were categorized as to be those firms having higher liquidity, lower growth options, larger in size, lower leverage, higher managerial ownership, lower profitability and higher foreign exposure as compared to the non users of foreign currency derivatives. Logit regression model was used to investigate different factors affecting firm’s derivatives usage for hedging its foreign exchange risk. Results of the logit model illustrate that there is significantly positive relationship between firm size, liquidity, foreign exposure and managerial ownership. The results also show that corporations with higher liquidity, larger size, and larger managerial ownership are more likely to use foreign currency derivatives usage for hedging. Further results illustrate negative significant relationship between growth opportunities, leverage

Therefore, the academicians as well as the investment managers have started taking great interest in studying the interaction between stock and foreign exchange markets, as the stock market serves as a composite indicator of the value of investments in an economy. This interaction can be examined at different levels—at firm-level, at industry-level and at aggregate market level. The ‘flow-oriented’ model of Dornbusch and Fischer (1980) postulates that a change in exchange rate affects a firm’s operational exposure, its competitiveness in the international market and, consequently, its share prices. At macro level, the impact of exchange rate fluctuations on stock market depends on the relative importance of international trade in the economy and the nature of trade imbalances of the country. Ma and Kao (1990) find that the currency appreciation negatively affects the domestic stock market for an export-dominant country and positively affects the domestic stock market for an import-dominant country. The portfolio balancing model (Branson, 1983; Frankel, 1983; and Smith, 1992), on the other hand, suggests that the excessive foreign investment flow induced by booming capital market increases the demand for local currency, which leads to appreciation of the currency. Since the pay-off of foreign investors depends on changes in exchange rate as well as

Foreign currency exchange risk is the additional riskiness or varience of a firm’s cash flows that may be attributed to currency fluctuations (Giddy, 1977, Brigham and Ehrhardt, 2005). Normally, foreign currency risk exists in three forms; translation, transaction and economic exposures.

Exchange rate risk is faced by businesses and investors due to change in exchange rates. An exporter is likely to experience shrinking sales, gross margins or both when domestic currency appreciates or foreign currency depreciated. The impact of fluctuation in exchange rates has significant impact on SMEs. In general, when the domestic currency appreciates, importers benefit and exporters are adversely impacted and vice versa. However, the impact varies from sector to sector. Furthermore, the ability of different sectors to withstand the impact is not the same. For instance, the IT sector having higher margins than the handicrafts sector, can relatively withstand the adverse impact of the appreciation of the rupee to a greater level.