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

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.

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

Australian Journal of Management ◽

10.1177/0312896219830158 ◽

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

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Emerging market currency risk exposure: evidence from South Africa

The Journal of Risk Finance ◽

10.1108/jrf-07-2019-0123 ◽

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.

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

Journal of Central Banking Theory and Practice ◽

10.1515/jcbtp-2016-0015 ◽

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.

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Understanding Foreign Exchange Risk: An Instructional Simulation Exercise

Issues in Accounting Education ◽

10.2308/iace-50311 ◽

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.”

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The International Diversification Puzzle When Goods Prices Are Sticky: It's Really about Exchange-Rate Hedging, Not Equity Portfolios

American Economic Journal Macroeconomics ◽

10.1257/mac.1.2.155 ◽

2009 ◽

Vol 1 (2) ◽

pp. 155-188 ◽

Cited By ~ 58

Author(s):

Charles Engel ◽

Akito Matsumoto

Keyword(s):

Exchange Rate ◽

Foreign Exchange ◽

Contingent Claims ◽

Complete Markets ◽

Foreign Exchange Risk ◽

Exchange Risk ◽

Complete Set ◽

Equity Portfolios ◽

Linearized Model ◽

High Degree

This paper develops a two-country monetary DSGE model in which households choose a portfolio of home and foreign equities, and a forward position in foreign exchange. Some nominal goods prices are sticky. Trade in these assets achieves the same allocations as trade in a complete set of nominal state-contingent claims in our linearized model. When there is a high degree of price stickiness, we show that not much equity diversification is required to replicate the complete-markets equilibrium when agents are able to hedge foreign exchange risk sufficiently. Moreover, temporarily sticky nominal goods prices can have large effects on equity portfolios even when dividend processes are very persistent. (JEL E13, F41, G11, G15)

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