A Primer on the Exposure of Nonfinancial Corporations to Foreign Exchange Rate Risk

31 Pages Posted: 20 Oct 2006 Last revised: 23 Dec 2019

See all articles by Söhnke M. Bartram

Söhnke M. Bartram

University of Warwick; Centre for Economic Policy Research (CEPR)

Gunter Dufey

Stephen M. Ross School of Business at the University of Michigan ; Nanyang Technological University (NTU) - Centre for Research in Financial Services (CREFS)

Michael Frenkel

WHU Otto Beisheim Graduate School of Management

Date Written: August 19, 2010

Abstract

In the presence of deviations from parity conditions such as purchasing power parity and the international Fisher effect, non-financial corporations are confronted with risks stemming from the impact of unexpected exchange rate changes on the value of the firm, especially in the short and the medium term. This paper analyzes the economic exposure of non-financial firms, focusing on cash flows, against the backdrop that the existing academic literature and observed corporate practice have placed too much emphasis on either financial assets or hedging instruments, or forecasting rates in the latter case. In this context, issues such as the dimension of pass-through time and other complexities of exposures are explicitly addressed and such considerations in turn are linked to hedging decisions. The role of the competitive environment is stressed and related to analytical concepts such as currency of denomination and currency of determination. Finally, the complexity of the trade-off between financial and operative hedges is emphasized. The overall objective is to pull together diverse strands of the existing academic literature into a clear conceptual framework with the ultimate aim of improving managerial decision-making.

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

JEL Classification: G3, F4, F3

Suggested Citation

Bartram, Söhnke M. and Dufey, Gunter and Frenkel, Michael, A Primer on the Exposure of Nonfinancial Corporations to Foreign Exchange Rate Risk (August 19, 2010). Journal of Multinational Financial Management, Vol. 15, Nos 4/5, pp. 394-413, October/December 2005, WBS Finance Group Research Paper No. 70, Available at SSRN: https://ssrn.com/abstract=938948

Söhnke M. Bartram (Contact Author)

University of Warwick ( email )

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

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

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Gunter Dufey

Stephen M. Ross School of Business at the University of Michigan ( email )

701 Tappan Street
CSIB
Ann Arbor, MI 48109-1234
United States
650-249-3483 (Fax)

Nanyang Technological University (NTU) - Centre for Research in Financial Services (CREFS)

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Banking and Finance
Singapore 639798
Singapore

Michael Frenkel

WHU Otto Beisheim Graduate School of Management ( email )

Burgplatz 2
Vallendar, 56179
Germany
0049 261 6509281 (Phone)
0049 261 6509279 (Fax)

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