Hedging Foreign Exchange Exposure: Risk Reduction from Transaction and Translation Hedging

22 Pages Posted: 14 May 2001

Multiple version iconThere are 2 versions of this paper

Date Written: May 28, 2002

Abstract

Using a sample of Swedish firms we investigate the risk reducing effect of foreign exchange exposure hedging. Further, we investigate risk reduction from using different hedging instruments, and particular interest is directed towards the impact of transaction exposure hedges and translation exposure hedges respectively. We find that firms' foreign exchange exposure is increasing with the level of inherent exposure, measured as the difference between revenues and costs denominated in foreign currency, and that it is decreasing with firm size. We find a significant reduction in foreign exchange exposure from the use of financial hedges. The evidence suggests that the usage of foreign denominated debt as well as currency derivatives reduce firms' foreign exchange exposure. Further, we find that transaction exposure hedges significantly reduce exposure, and that translation exposure hedges also reduce exposure. A possible explanation for the latter is that translation exposure approximates the exposed value of future cash flows from operations in foreign subsidiaries (i.e. economic exposure). If so, by hedging translation exposure, economic exposure is reduced.

Keywords: Foreign Exchange, Exposure, Hedging, Derivatives

Suggested Citation

Hagelin, Niclas and Pramborg, Bengt, Hedging Foreign Exchange Exposure: Risk Reduction from Transaction and Translation Hedging (May 28, 2002). EFMA 2001 Lugano Meetings. Available at SSRN: https://ssrn.com/abstract=269882 or http://dx.doi.org/10.2139/ssrn.269882

Niclas Hagelin

Nordea Bank, Nordea Markets ( email )

Hamngatan 10
Stockholm, SE-105 71
Sweden

Bengt Pramborg (Contact Author)

Swedbank ( email )

SE-105 34 Stockholm
Sweden

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