No puzzle: The foreign exchange exposure of Australian firms

In this paper we analyze the constant and time-varying influence of currency movements on the value of Australian firms listed on the S&P/ASX 100 index for a period from 1980 to 2010 using daily, weekly, monthly and quarterly returns. Whilst the constant exposure model provides only weak evidence over the full sample period the time-varying exposure analysis reveals that most firms are exposed to currency movements in some periods. The exchange rate exposure of Australian firms is dependent on the appreciation or depreciation trajectory of the Australian dollar and on the sample frequencies used. The positive average FX exposure is consistent with the structure of the Australian economy, the size of the mining sector and the role of the Australian dollar as a commodity currency. Finally, we argue that our findings are fully consistent with financial theory and do not constitute a puzzle.     

Exchange rate exposure, foreign involvement and currency hedging of firms: some Swedish evidence

This paper investigates the effect of exchange rate fluctuation on a firm's value, the so-called exchange rate exposure, for a sample of Swedish firms. In contrast to previous results, using U.S. data, the values of Swedish firms, as reflected in the stock price, seem quite sensitive to movements in the exchange rate. Studying the cross sectional differences in exposure, the estimated exposure is positively and significantly related to the fractional of total sales made abroad and negatively related to the use of currency derivatives.
F30, G10     

Unconditional and conditional exchange rate exposure

We re-examine the relationship between exchange rate movements and firm value. We estimate the exchange rate exposure of U.S. firms to two currency indices. Firms are clustered into eleven industries. The sample includes exporters and non-exporters. Using a panel approach, we uncover statistically significant and sizable unconditional exposure. We also examine the dynamics of exchange rate exposure modeled as a function of business cycle indicators and firm characteristics. We find that exposure varies over time with macroeconomic and financial variables and increases during economic contractions. Deviations from the unconditional measure of exposure driven by the macroeconomic variables are economically meaningful.     

Exchange Rate Exposure at the Firm and Industry Level

Previous work on the exposure of firms to exchange rate risk has primarily focused on U.S. firms and, surprisingly, found stock returns were not significantly affected by exchange‐rate fluctuations. The equity market premium for exposure to currency risk was also found to be insignificant. In this paper we examine the relation between Japanese stock returns and unanticipated exchange‐rate changes for 1,079 firms traded on the Tokyo stock exchange over the 1975–1995 period. Second, we investigate whether exchange‐rate risk is priced in the Japanese equity market using both unconditional and conditional multifactor asset pricing testing procedures. We find a significant relation between contemporaneous stock returns and unanticipated yen fluctuations. The exposure effect on multinationals and high‐exporting firms, however, is found to be greater in comparison to low‐exporting and domestic firms. Lagged‐exchange rate changes on firm value are found to be statistically insignificant implying that investors are able to assess the impact of exchange‐rate changes on firm value with no significant delay. The industry level analysis corroborates the cross‐sectional findings for Japanese firms in that they are sensitive to contemporaneous unexpected exchange‐rate fluctuations. The co‐movement between stock returns and changes in the foreign value of the yen is found to be positively associated with the degree of the firm's foreign economic involvement and inversely related to its size and debt to asset ratio. Asset pricing tests show that currency risk is priced. We find corroborating evidence in support of the view that currency exposure is time varying. Our results indicate that the foreign exchange‐rate risk premium is a significant component of Japanese stock returns. The combined evidence from the currency exposure and asset pricing analyses, suggests that currency risk is priced and, therefoe, has implications for corporate and portfolio managers.     

A resolution of the distress risk and leverage puzzles in the cross section of stock returns

We revisit findings that returns are negatively related to financial distress intensity and leverage. These are puzzles under frictionless capital markets assumptions but are consistent with optimizing firms that differ in their exposure to financial distress costs. Firms with high costs choose low leverage to avoid distress, but they retain exposure to the systematic risk of bearing such costs in low states. Empirical results are consistent with this explanation. The return premiums to low leverage and low distress are significant in raw returns, and even stronger in risk-adjusted returns. When in distress, low-leverage firms suffer more than high-leverage firms as measured by a deterioration in accounting operating performance and heightened exposure to systematic risk. The connection between return premiums and distress costs is apparent in subperiod evidence. Both are small or insignificant prior to 1980 and larger and significant thereafter.     

Asymmetric foreign exchange risk exposure: Evidence from U.S. multinational firms

This paper examines how U.S. multinational firms are affected by foreign currency movements. In light of detailed exchange rate data, we find that 29% of our sample of 935 U.S. firms with real operations in foreign countries is significantly affected by currency movements between 1990 and 2001. Results show moreover that U.S. stock returns react asymmetrically to currency movements. By introducing nonlinearity in foreign currency risk exposure, we noticeably increase the precision and the significance of exposure estimates. We demonstrate moreover that asymmetries are more pronounced towards large versus small currency fluctuations than over depreciation and appreciation cycles.     

Exchange rate exposure and the use of foreign currency derivatives in the Australian resources sector

In this paper, we provide a re-examination of the exchange rate exposure and foreign currency derivative use by Australian resources firms in the 2006–2009 period which is characterized by increased volatility caused by the global financial crisis. In particular, we consider the interaction of a resources firm's exchange rate risk exposures, foreign currency derivative use and the global financial crisis simultaneously. Conforming to expectations, our results indicate that more companies are significantly exposed to exchange rate risk since the onset of the financial crisis. However, there is a lack of evidence that the use of foreign currency derivative is more effective in alleviating exchange rate exposures during the crisis as opposed to the pre-crisis period.     

Foreign Exchange Risk,Hedging, and Tax-Motivated Outbound Income Shifting

Although outbound income shifting to low-tax jurisdictions provides tax savings, it is often accompanied by nontax costs. In this study, I examine whether foreign exchange (FX) risk constrains tax-motivated outbound income shifting by U.S. multinational corporations. My findings indicate that exposure to greater currency volatility is associated with less outbound income shifting, and this effect is stronger for firms with foreign affiliates using foreign functional currencies. I also investigate whether hedging facilitates outbound income shifting. Consistent with hedging lowering costs associated with exchange rate volatility, I find that U.S. firms that use more currency derivatives tend to shift more income to low-tax foreign jurisdictions. Overall, these findings suggest that FX risk is an important cost of outbound income shifting.     

Pass-through and Exposure

Firms differ in the extent to which they "pass through" changes in exchange rates into foreign currency prices and in their "exposure" to exchange rates—the responsiveness of their profits to changes in exchange rates. Because pricing affects profitability, a firm's pass-through and exposure should be related. This paper develops models of exporting firms under imperfect competition to study these related phenomena. From these models we derive the optimal pass-through decisions and the resulting exchange rate exposure. The models are estimated on eight Japanese export industries using both the price data pass-through and financial data for exposure.     

Valuation impact of currency crises: Evidence from the ADR market

This study analyzes American depository receipts (ADR) performance surrounding the outbreak of major currency crises during the past decade. By employing event-study methodologies and multifactor pricing models, we find that the outbreak of a currency crisis is accompanied by a negatively significant abnormal return for the corresponding ADRs, even after controlling for variations in exchange rates. We also find significant upward shifts in the exchange rate exposure of ADRs when the home currency is switched from a “pegging” to a “floating” exchange rate regime. In addition, ADR-originating firms with larger sizes, greater proportions of U.S. market activities, and greater market liquidity have relatively less negative abnormal returns (ARs) and less significant upward shifts in currency exposure, implying that such firms are relatively better hedged against currency crises.     

The Importance of Corporate Foreign Debt in Managing Exchange Rate Exposures in Non‐Financial Companies

This empirical study of the exchange rate exposure management of Danish non‐financial firms listed on the Copenhagen Stock Exchange shows that debt denominated in foreign currency (‘foreign debt’) is a very important alternative to the use of currency derivatives. The results show that the relative importance of foreign debt is positively related to (1) the extent of foreign subsidiaries, (2) the relative value of assets in place, and (3) the debt ratio. The pivotal role of time horizon is emphasised. These findings are important to firms in other countries with open economies.     

Crossing the lines: The conditional relation between exchange rate exposure and stock returns in emerging and developed markets

This paper examines the importance of exchange rate exposure in the return generating process for a large sample of non-financial firms from 37 countries. We argue that the effect of exchange rate exposure on stock returns is conditional and show evidence of a significant return impact to firm-level currency exposures when conditioning on the exchange rate change. We further show that the realized return to exposure is directly related to the size and sign of the exchange rate change, suggesting fluctuations in exchange rates as a source of time-variation in currency return premia. For the entire sample the return impact ranges from 1.2 to 3.3% per unit of currency exposure, and it is larger for firms in emerging markets compared to developed markets. Overall, the results indicate that foreign exchange rate exposure estimates are economically meaningful, despite the fact that individual time-series results are noisy and many exposures are not statistically significant, and that exchange rate exposure plays an important role in generating cross-sectional return variation. Moreover, we show that the relation between exchange rate exposure and stock returns is more consistent with a cash flow effect than a discount rate effect.     

Stock return exposure to exchange rate risk: A perspective from delayed reactions and hedging effects

This paper investigates the absence of prevailing evidence on the significant exposure of US stocks to exchange rate risk by considering a firm's pre-hedging currency exposure, its expected hedging activity and the delayed reaction of its stocks to currency movements. Although we demonstrate the importance of lagged exposure relative to contemporaneous exposure, the inclusion of the lagged effect in the exposure measurement still fails to raise the significance of the exchange rate risk with regard to the pricing for the overall sample of stocks. We further demonstrate that the weak evidence on priced currency risk is at least partly attributable to hedging activity, particularly for large firms. Finally, our results provide partial support for the asymmetric hedging hypothesis, in that asymmetric hedging is found to be responsible for reshaping the relationship between a firm's characteristics and its currency exposure.     

Is operational hedging a substitute for or a complement to financial hedging?

This paper investigates operational hedging by firms and how operational hedging is related to financial hedging by using a sample of 424 firm observations, which consist of 212 operationally hedged firms (firms with foreign sales) and a size- and industry-matched sample of 212 non-operationally hedged firms (firms with export sales). We find that non-operationally hedged firms use more financial hedging, relative to their levels of foreign currency exposure, as measured by the amount of export sales. On the other hand, though operationally hedged firms have more currency exposure, their usage of financial derivatives becomes much smaller than that of exporting firms. These results can explain why some global firms use very limited amount of financial derivatives for hedging purpose despite much higher levels of currency risk exposure. We also show that hedging increases firm value.     

Why and How UK Firms Hedge

This paper attempts to differentiate among the theories of hedging by using disclosures in the annual reports of 400 UK companies and data collected via a survey. I find, unlike many previous US studies, strong evidence linking the decision to hedge and the expected costs of financial distress. The tests show that this is mainly because my definition of hedging includes all hedgers and not just derivative users. However, when the tests employ the same hedging definition as previous US studies, financial distress cost factors still appear to be more important for this sample than samples of US firms. Therefore, a secondary explanation for the strong financial distress results might be due to differences in the bankruptcy codes in the two countries, which result in higher expected costs of financial distress for UK firms. The paper also examines the determinants of the choice of hedging method distinguishing between non‐derivative and derivatives hedging. My evidence shows that larger firms, firms with more cash, firms with a greater probability of financial distress, firms with exports or imports and firms with more short‐term debt are more likely to hedge with derivatives. Thus, differences in opportunities, in incentives for reducing risk and in the types of financial price exposure play an important role in how firms hedge their risks.     

The Global CAPM and a Firm's Cost of Capital in Different Currencies

In an integrated global market, a firm's cost of capital expressed in one currency should be consistent with its cost of capital expressed in another currency. This article presents and illustrates a process for estimating consistent costs of capital in different currencies for a U.K. based multinational. In so doing, it uses a simple, easy-to-use version of the global CAPM that attempts to incorporate the effect of uncertain exchange rates by calculating exchange rate "betas." As argued in the previous article, at least part of a company's currency exposure is systematically related to the global market and thus should be treated as a component of the firm's systematic equity risk.
For example, the U.K. firm featured in this article is shown to have an exchange rate beta of 0.20 from the perspective of a U.S. investor. This implies that a 10% return on the global market in U.S. dollars tends to be associated with a 2% change in the U.S. dollar value of the British pound. One interesting consequence of incorporating exchange risk in this fashion is that two firms with identical U.S. global betas and costs of equity will have different expected returns expressed in another currency if they have different exposures to that currency.     

Exchange Rate Exposure,Foreign Currency Debt,and the Use of Derivatives: Evidence from Brazil

This paper studies the exchange rate exposure and its determinants for a sample of nonfinancial Brazilian companies from 1996 to 2006. The results indicate that the number of firms exposed to exchange rate fluctuations is higher in periods of crisis and under a fixed exchange rate regime. In addition, the results point out that, although companies' international activities, operational hedging, and financial policies are important determinants of firms' exposure, the changes in companies' exposure that took place when Brazil moved from a fixed to a floating exchange rate regime were mainly driven by changes in companies' foreign currency borrowing and the use of derivatives that occurred in that period.     

Financial sector development and dollarization in emerging economies

This paper discusses important features of financial dollarization and its implications for the macro economy and financial sector deepening. Despite the need to slow down the rate of inflation and keep exchange rates under control, to achieve growth and economic development, monetary policies may permit increases in the base money to keep pace with real GDP growth. In heavily dollarized economies, during periods of sharp devaluations of the domestic currency, financial assets and liabilities shift toward foreign currency, exacerbating downward pressure on the exchange rate. When central banks face pressures to keep the exchange rate steady in nominal terms, interest rates in the domestic currency are set at levels substantially higher than those on dollar assets. In such states of the world, banks prefer to lend to the government sector at these higher rates than to the private sector. Although private firms may benefit from lower rates on dollar loans, they also face significant exchange rate or currency risk due to the currency mismatch emerging from their dollar debt while their receivables may tilt toward domestic currency denominated instruments. This weakens their balance sheet, which in turn increases the exposure of the banking sector to a variety of risks.     

Measuring the economic importance of exchange rate exposure

This paper re-examines the nature and the economic significance of the exchange rate to firm value relation using a database of non-financial firms from over 18 countries. Our main contribution is to apply a portfolio approach to investigate the economic importance of exposure. We find that firms with high international sales outperform those with no international sales during periods of large currency depreciations by 0.72% per month, whereas they underperform by 1.10% per month during periods of large currency appreciations. In contrast to the previous literature, our evidence shows that exchange rate movements can have an economically significant impact on firm value.