What Lies Beneath: Foreign Exchange Rate Exposure, Hedging and Cash Flows

Journal of Banking and Finance, Vol. 32, No. 8, pp. 1508-1521, August 2008

EFA 2006 Zurich Meetings Paper

32 Pages Posted: 30 May 2006 Last revised: 11 Mar 2014

Söhnke M. Bartram

Warwick Business School - Department of Finance

Date Written: June 1, 2007

Abstract

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.

Keywords: Foreign exchange rates, exposure, risk management, cash flow, derivatives, corporate finance

JEL Classification: G3, F4, F3

Suggested Citation

Bartram, Söhnke M., What Lies Beneath: Foreign Exchange Rate Exposure, Hedging and Cash Flows (June 1, 2007). Journal of Banking and Finance, Vol. 32, No. 8, pp. 1508-1521, August 2008; EFA 2006 Zurich Meetings Paper. Available at SSRN: https://ssrn.com/abstract=905087 or http://dx.doi.org/10.2139/ssrn.905087

Söhnke M. Bartram (Contact Author)

Warwick Business School - Department of Finance ( email )

Coventry, CV4 7AL
United Kingdom
+44 (24) 7657 4168 (Phone)
+1 425 952 1070 (Fax)

HOME PAGE: http://go.warwick.ac.uk/sbartram/

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