What Lies Beneath: Foreign Exchange Rate Exposure, Hedging and Cash Flows
Söhnke M. Bartram
Warwick Business School - Department of Finance
June 1, 2007
Journal of Banking and Finance, Vol. 32, No. 8, pp. 1508-1521, August 2008
EFA 2006 Zurich Meetings Paper
This paper presents results from an in-depth analysis of the foreign exchange rate exposure of a large nonfinancial firm based on proprietary internal data including cash flows, derivatives and foreign currency debt, as well as external capital market data. While the operations of the multinational firm have significant exposure to foreign exchange rate risk due to foreign currency-based activities and international competition, corporate hedging mitigates this gross exposure. The analysis illustrates that the insignificance of foreign exchange rate exposures of comprehensive performance measures such as total cash flow can be explained by hedging at the firm level. Thus, the residual net exposure is economically and statistically small, even if the operating cash flows of the firm are significantly exposed to exchange rate risk. The results of the paper suggest that managers of nonfinancial firms with operations exposed to foreign exchange rate risk take savvy actions to reduce exposure to a level too low to allow its detection empirically.
Number of Pages in PDF File: 32
Keywords: Foreign exchange rates, exposure, risk management, cash flow, derivatives, corporate finance
JEL Classification: G3, F4, F3
Date posted: May 30, 2006 ; Last revised: March 11, 2014
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