Understanding Foreign Exchange Risk: An Instructional Simulation Exercise

2012 ◽  
Vol 28 (1) ◽  
pp. 181-195
Author(s):  
Joyce A. van der Laan Smith
Keyword(s):  
Exchange Rate ◽  
Foreign Exchange ◽  
Foreign Currency ◽  
Financial Statements ◽  
Thinking Skills ◽  
Critical Thinking Skills ◽  
Foreign Exchange Risk ◽  
The United Kingdom ◽  
Exchange Risk ◽  
The Exchange Rate

ABSTRACT: This paper presents an instructional exercise designed to promote the learning of foreign exchange risk and accounting for foreign currency transactions. To promote critical thinking skills, the exercise uses an unstructured problem-solving format. I use the United Kingdom (U.K.) MONOPOLY™ board game to simulate a U.S. company investing in London real estate. Students conduct all transactions, on account, in British Pounds (GBP), maintain journals in U.S. dollars (USD), and prepare financial statements at game-end in USD. The instructor sets the exchange rate at the beginning of the game, changes it mid-game, and then offers a forward contract. The instructor alters the exchange rate again at the end of the game. Students perceived the exercise as effective in understanding foreign exchange risk and in learning the accounting for foreign currency transactions. Content analysis of students' responses about the exercise reveals that the most frequently used words in the comments were “fun” and “learn.”

scholarly journals Exchange Rates and Liquidity Risk

2020 ◽  
Vol 11 (2) ◽  
pp. 159
Author(s):  
Martin D.D. EVANS
Keyword(s):  
Risk Factors ◽  
Exchange Rates ◽  
Foreign Exchange ◽  
Foreign Currency ◽  
Liquidity Risk ◽  
Risk Premia ◽  
Time Varying ◽  
Foreign Exchange Risk ◽  
Exchange Risk

I use Forex trading data to study how risks associated with the lack of liquidity contribute to the dynamics of 17 spot exchange rates through their time-varying contributions to risk premia. I find that liquidity risk matters. All the foreign exchange risk premia compensate investors for exposure to liquidity risk; and, for many currencies, exposure to liquidity risk appears to be more important than exposure to the traditional carry and momentum risk factors. I also find that variations in the price of liquidity risk make economically important contributions to the behavior of individual foreign currency returns: they account for approximately 34%, on average, of the variability in currency returns compared to the contribution of approximately 8% from the prices of carry and momentum risk.

The impact of exchange volatility exposure on firms’ foreign-denominated debts

2019 ◽  
Vol 57 (11) ◽  
pp. 3035-3060 ◽  
Author(s):  
Yujuana Min ◽  
Oh Suk Yang
Keyword(s):  
Risk Management ◽  
Foreign Exchange ◽  
Foreign Currency ◽  
Management Strategies ◽  
Foreign Exchange Risk ◽  
Content Type ◽  
Exchange Risk ◽  
Foreign Exchange Exposure ◽  
Foreign Exchange Volatility ◽  
Exchange Risk Management

Purpose This research began by acknowledging that conventional analysis on the foreign exchange exposure could not adequately reflect firms’ risk management strategies, which firms take actions against uncertainties raised by foreign exchange. In order to conceptualize uncertainty aroused by foreign exchange, the purpose of this paper is to develop an index that could measure corporate profits’ sensitivity to foreign exchange uncertainty and examine its possibility of utilization. Design/methodology/approach As an alternative to foreign exchange exposure, the present research derived the foreign exchange volatility exposure and analyzed the determinants of foreign currency-denominated debt in terms of foreign exchange volatility exposure. The foreign exchange volatility exposure draws from partially differentiating a firm’s operating profits to the exchange rate volatility. Findings The major findings are as follows. First, before the Asian financial crisis, South Korean enterprises had similar responses to the exchange volatility exposure as compared with the exchange exposure on procuring foreign-denominated debt. Second, since the global financial crisis (GFC), not only have Korean firms’ response mechanisms to both exposures changed, but also the significance of exchange volatility exposure has been further emphasized. Furthermore, Korean companies have dealt with exchange uncertainties by decreasing foreign-denominated debt as their foreign exchange volatility exposure increased after GFC. In contrast, the influence of conventional exchange exposure on foreign-denominated debt has diminished. Research limitations/implications Future research should focus on several points. First, additional research could extend to foreign investors who have divergent perception and consideration in regard to foreign exchange risk management. Second, research on decision making and motivation in foreign currency choice should be conducted in order to deepen academic understanding. Third, research that refines the variables added in the current research should be conducted. Finally, as a way to manage foreign exchange volatility exposure, further investigation based on this study is possible. Practical implications The results of this study have several important theoretical and empirical implications for companies’ foreign exchange risk management strategy. First, through foreign exchange volatility exposure, which can usefully take over the role of the existing foreign exchange exposure, the authors can confirm market uncertainty as being relevant to the foreign exchange risk management strategy. Second, through the financial influence that the foreign exchange volatility exposure has on the foreign currency-denominated debt, the authors can observe the Korean firms’ paradigm shifts in their foreign exchange risk management strategies. Originality/value This research confirms the importance of foreign exchange volatility exposure in the research works dealing with firms’ exchange risk management, also the possible influence of foreign exchange volatility exposure in the future might be increased as uncertainty is raised from foreign exchange escalating.

Equity-linked executive compensation, hedging and foreign exchange exposure: Australian evidence

2019 ◽  
Vol 45 (1) ◽  
pp. 72-93
Author(s):  
Blake Loriot ◽  
Elaine Hutson ◽  
Hue Hwa Au Yong
Keyword(s):  
Risk Management ◽  
Exchange Rate ◽  
Executive Compensation ◽  
Foreign Exchange ◽  
Jel Classification ◽  
Foreign Exchange Risk ◽  
Exchange Rate Movements ◽  
Exchange Risk ◽  
Foreign Exchange Exposure ◽  
Exchange Risk Management

Using a sample of 268 Australian firms over the period 2009–2014, we examine the relation between the equity-linked compensation (shares and options) of Australian executives – CEOs, CFOs and directors – and firms’ foreign exchange hedging programmes. We find that the greater the number of shares held by CEOs, the higher its exposure to exchange rate movements. While this suggests that remuneration in the form of shares has a critical downside, we also find evidence for a more positive and important role in foreign exchange risk management for the share- and option-related incentives provided to CFOs. JEL Classification: G32, G15, F31

Emerging market currency risk exposure: evidence from South Africa

2020 ◽  
Vol 21 (2) ◽  
pp. 159-179
Author(s):  
Mashukudu Hartley Molele ◽  
Janine Mukuddem-Petersen
Keyword(s):  
South Africa ◽  
Exchange Rate ◽  
Foreign Exchange ◽  
Factor Model ◽  
Five Factor Model ◽  
Risk Exposure ◽  
Foreign Exchange Risk ◽  
Content Type ◽  
Exchange Risk ◽  
Three Factor

Purpose The purpose of this paper is to examine the level of foreign exchange exposure of listed nonfinancial firms in South Africa. The study spans the period January 2002 and November 2015. Foreign exchange risk exposure is estimated in relation to the exchange rate of the South African Rand relative to the US$, the Euro, the British Pound and the trade-weighted exchange rate index. Design/methodology/approach The study is based on the augmented-market model of Jorion (1990). The Jorion (1990) is a capital asset pricing model-inspired framework which models share returns as a function of the return on the market index and changes in the exchange rate factor. The market risk factor is meant to discount the effect of macroeconomic factors on share returns, thus isolating the foreign exchange risk factor. In addition, the study further added the size, value, momentum, investment and profitability risk factors in line with the Fama–French three-factor model, Carhart four-factor model and the Fama–French five-factor model to account for the fact that equity capital markets in countries such as South Africa are known to be partially segmented. Findings Foreign exchange risk exposure levels were estimated at more than 40% for all the proxy currencies on the basis of the standard augmented market model. However, after controlling for idiosyncratic factors, through the application of the Fama–French three-factor model, the Carhart four-factor model and the Fama–French five-factor model, exposure levels were found to range between 6.5 and 12%. Research limitations/implications These results indicate the importance of controlling for the effects of idiosyncratic facto0rs in the estimation of foreign exchange risk exposure in the context of emerging markets of Sub-Saharan Africa (SSA). Originality/value This is the first study to apply the Fama–French three-factor model, Carhart four-factor model and the Fama–French five-factor model in the estimation of foreign exchange exposure of nonfinancial firms in the context of a SSA country. These results indicate the importance of controlling for the effects of idiosyncratic factors in the estimation of foreign exchange risk exposure in the context of emerging markets.

scholarly journals The Interaction Between FX and Credit Risk as an Example of Intersection of Monetary and Financial Stability Policy Goals – The Case of Serbia

2016 ◽  
Vol 5 (2) ◽  
pp. 133-155
Author(s):  
Željko Jović
Keyword(s):  
Exchange Rate ◽  
Credit Risk ◽  
Exchange Rates ◽  
Foreign Exchange ◽  
Financial Stability ◽  
Financial System ◽  
Price Stability ◽  
Foreign Exchange Risk ◽  
Exchange Risk ◽  
The Impact

Abstract The financial system of Serbia is highly bank-centric and euroised, which is a common specific feature of financial systems in developing countries. High level of euroisation represents an adequate environment for the development of emphasized interaction of foreign exchange and credit risks; therefore, creation of the spillover mechanism of foreign exchange risk to credit risk is immanent for euroised systems. Although maintaining the stability of the dinar exchange rate is a secondary goal of the National Bank of Serbia in relation to price and financial stability as the primary goals, in terms of existence of the aforesaid spillover mechanism, maintaining stability of the dinar exchange rate represents the area where there is an interaction between the goals of monetary policy (price stability) and those of financial stability policy (maintaining and strengthening the financial system’s stability). In order to explore whether the spillover mechanism of foreign exchange risk to credit risk exists in Serbia’s financial system, the vector autoregressive (VAR) model is applied on data from the Serbian banking sector to quantify the impact of changes in the dinar exchange rates on the rate of non-performing loans (NPLs); the sample was formed in the period of increased instability of the dinar exchange rate, from 31 January 2008 to 31 December 2010. As we have quantitatively confirmed the impact of increase in the dinar exchange rate on the increase of 90-120 days past due NPLs, we can conclude that the existence of expressed interaction between foreign exchange risk and credit risk in the Serbian financial system represents a paradigm of the regulator’s need to achieve contemporary goals of monetary and financial stability policy by maintaining relative stability of the dinar exchange rates. Depreciation of the local currency has inflationary pressure on price stability and simultaneously influences the achievement of financial stability goals through the spillover mechanism of foreign exchange risk to credit risk. In addition to taking systematic measures to reduce the level of euroisation and introduce the specific regulatory requirements, in order to protect banks and clients from the dinar exchange rate volatility, the regulator faces extremely important task of maintaining relative stability of the dinar exchange rate as the instrument to simultaneous achievement of goals of monetary and financial stability policies.

The Choice of Invoicing Currency in Merchandise Trade

1981 ◽  
Vol 98 ◽  
pp. 60-72 ◽  
Author(s):  
S.A.B. Page
Keyword(s):  
Exchange Rate ◽  
Foreign Currency ◽  
Exchange Rate Change ◽  
Aggregate Level ◽  
Foreign Exchange Risk ◽  
Exchange Risk ◽  
Balance Of Trade ◽  
Exchange Rate Changes ◽  
Merchandise Trade ◽  
Invoicing Currency

If an exporter or importer uses a foreign currency, his income or costs will be immediately affected when the exchange rate changes; if he uses his own, there will be no effect on contracts that are already fixed. Analysing the pattern of invoicing throws light on what objectives are important in firms' decisions, and in particular on their attitudes toward foreign exchange risk. At the aggregate level, their choice of currency influences the effect of an exchange rate change on a country's balance of trade.

scholarly journals An Intelligent Event-Sentiment-Based Daily Foreign Exchange Rate Forecasting System

2019 ◽  
Vol 9 (15) ◽  
pp. 2980 ◽  
Author(s):  
Muhammad Yasir ◽  
Mehr Yahya Durrani ◽  
Sitara Afzal ◽  
Muazzam Maqsood ◽  
Farhan Aadil ◽  
...  
Keyword(s):  
Deep Learning ◽  
Exchange Rate ◽  
Foreign Exchange ◽  
Foreign Currency ◽  
Foreign Exchange Rate ◽  
Exchange Rate Forecasting ◽  
Currency Exchange ◽  
Currency Exchange Rate ◽  
Us Dollar ◽  
The Exchange Rate

Financial time series analysis is an important research area that can predict various economic indicators such as the foreign currency exchange rate. In this paper, a deep-learning-based model is proposed to forecast the foreign exchange rate. Since the currency market is volatile and susceptible to ongoing social and political events, the proposed model incorporates event sentiments to accurately predict the exchange rate. Moreover, as the currency market is heavily dependent upon highly volatile factors such as gold and crude oil prices, we considered these sensitive factors for exchange rate forecasting. The validity of the model is tested over three currency exchange rates, which are Pak Rupee to US dollar (PKR/USD), British pound sterling to US dollar (GBP/USD), and Hong Kong Dollar to US dollar (HKD/USD). The study also shows the importance of incorporating investor sentiment of local and foreign macro-level events for accurate forecasting of the exchange rate. We processed approximately 5.9 million tweets to extract major events’ sentiment. The results show that this deep-learning-based model is a better predictor of foreign currency exchange rate in comparison with statistical techniques normally employed for prediction. The results present evidence that the exchange rate of all the three countries is more exposed to events happening in the US.

The additional cost of hedging in foreign currency loans

2017 ◽  
Vol 43 (2) ◽  
pp. 305-327 ◽  
Author(s):  
Viet Do ◽  
Tram Vu
Keyword(s):  
Foreign Exchange ◽  
Foreign Currency ◽  
Jel Classification ◽  
Management Tool ◽  
Risk Exposure ◽  
Foreign Exchange Risk ◽  
Macroeconomic Conditions ◽  
Exchange Risk ◽  
Corporate Funding ◽  
Cost Of Hedging

Foreign currency denominated loans ( FCDLs) are an important part of corporate funding as well as an operational risk management tool. We show that domestic borrowers use FCDLs to hedge their foreign exchange risk exposure. FCDLs are found to carry an interest rate premium over domestic currency loans after controlling for borrower characteristics, loan characteristics, and macroeconomic conditions. We argue that borrowers are willing to pay this premium since the marginal benefit of FCDLs as a natural hedge outweighs the marginal cost. From a lender’s perspective, this premium reflects a compensation for additional foreign exchange risk exposure and intensified monitoring efforts. These results are robust to endogeneity-corrected estimations. JEL Classification: G21, G32

scholarly journals Need for Managing own Exposure to Foreign Exchange Risk: Empirical Evidence from the Nigerian Economy

2017 ◽  
Vol 3 (2) ◽  
pp. 91-100
Author(s):  
Bello A. Ibrahim ◽  
Musa Talba Jibrin ◽  
Daud Mustafa ◽  
Abubakar Jamilu Baita
Keyword(s):  
Exchange Rate ◽  
Foreign Exchange ◽  
Secondary Data ◽  
Basic Knowledge ◽  
Foreign Exchange Risk ◽  
Public And Private ◽  
Dollar Exchange Rate ◽  
Goods And Services ◽  
Rate Fluctuation ◽  
Exchange Risk

Purpose: The Nigerian national currency (the Naira) has suffered series of exchange rate fluctuation on numerous occasions in the last two years. As a result, the value of the currency has changed significantly and rapidly many times, impacting on both visible and invisible trade. It is common today to hear importers, exporters and even consumers complaining about the adverse consequences of these trends which manifested in form of general rise in prices of goods and services.   Studies have shown that many Nigerian foreign traders, particularly those in the small and medium sector, either lack the basic knowledge on how to manage foreign exchange risk or are skeptical about its efficacy. This is surprising considering how costly, in terms of cash flow and profitability, unfavorable changes in the value of the Naira can be. In response to this gap, this paper utilized secondary data on Naira/Dollar exchange rate spanning over 18 months period (January 2015 to June 2016), to provide an empirical understanding of the intricacies of Naira/Dollar exchange rate and how the resultant trends can affect domestic users of foreign exchange in Nigeria and hence the need to privately manage same. The paper thus introduces the subject matter of foreign exchange risk, its determination/calculation using facts and figures and its management to both the public and private business sectors in Nigeria. The empirical results clearly established why it makes sense for stakeholders to reduce exposure to currency risk. The paper also highlighted some of the common techniques and instruments that can be used to mitigate this risk.

scholarly journals Foreign exchange transaction exposure of enterprises in Serbia

2016 ◽  
Vol 61 (209) ◽  
pp. 161-177
Author(s):  
Jasmina Bogicevic ◽  
Ljiljana Dmitrovic-Saponja ◽  
Marija Pantelic
Keyword(s):  
Foreign Exchange ◽  
Management Practices ◽  
Foreign Currency ◽  
Negative Impact ◽  
Practical Importance ◽  
Cash Flows ◽  
Foreign Exchange Risk ◽  
Exchange Rate Fluctuations ◽  
Exchange Risk ◽  
Foreign Enterprises

Enterprises involved in international business face transaction exposure to foreign exchange risk. This type of exposure occurs when an enterprise trades, borrows, or l?nds in foreign currency. Transaction exposure has a direct effect on an enterprise?s financial position and profitability. It is one of the three forms of exposure to exchange rate fluctuations, the other two being translation exposure and operating exposure. The aim of this paper is to assess the transaction exposure of enterprises in Serbia operating internationally. In addition to identifying and measuring transaction exposure, this paper explores the practical importance that enterprises in Serbia attach to management of this type of foreign exchange risk. We do not find significant differences between domestic and foreign enterprises in their choice of the type of foreign exchange risk exposure to manage. Although transaction exposure is the most managed type of foreign exchange risk, research has shown that, compared to foreign businesses, Serbian enterprises do not use sufficient protective measures to minimize the negative impact of this type of exposure on their cash flows and profitability. We expected that there would be a statistically significant dependence between the volume of enterprises? foreign currency transactions and the level of applied transaction exposure management practices. However, the results of our research, based on a sample of enterprises in Serbia operating internationally, show that transaction exposure management practices can be influenced by factors other than the level of an enterprise?s foreign currency transactions, such as the enterprise?s country of origin.

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