We use a two-stage framework (Cragg, 1971), to examine what determines corporations’ level of derivative use. This two-stage process allows us to examine separately a ? rm’s decision to hedge from its decision of how much to hedge. Similar to Geczy et al. (1997), we ? nd that ? rms with larger size, R&D expenditures, and exposure to exchange rates through foreign sales or foreign trade are more likely to use currency derivatives. These results are consistent with the Froot et al. (1993) theory of optimal hedging, and also high ? xed start-up costs of hedging explanations.
While these tests reveal the factors that prompt corporations to hedge, they do not answer the question of what determines the extent of hedging. Using—in the second stage of the estimation—the notional amount of currency derivatives for those ? rms that chose to hedge, we ? nd that exposure factors (foreign sales and foreign trade) are the sole determinants of the degree of hedging. In other words, given that a ? rm decides to hedge, the decision of how much to hedge is affected solely by its exposure to foreign currency movements through foreign sales and trade. This result 3
Clearly, the effect of exchange rates on share prices should be proportional to net revenues denominated in foreign currency—that is, foreign currency denominated revenues minus foreign currency denominated expenses—not, gross revenues. Firms, however, are only required to report foreign revenues (and only if foreign revenues are above 10% of total revenues) and provide no useful information about foreign expenses. Nevertheless, the use of the ratio of foreign sales to total sales should be a good proxy of the percentage of net foreign revenues (out of total revenues), if foreign pro?
The Term Paper on A Report On The Hedging Strategy Of CITIC Pacific Limited
This report is to check the hedging strategy that was used and lead to the huge loss of CITIC Pacific Limited and point out the importance of managing foreign exchange exposure through select appropriate hedging strategies. The huge loss of CITIC Pacific Limited and its cause is discussed in the first part. The importance of hedging and the tools of hedging are respectively reviewed in part two ...
Margins are similar to domestic margins. In that case, the ratio of foreign sales to total sales is proportional to the ratio of foreign net revenues to total net revenues. Also, the use of gross derivative positions, instead of net positions that we have to use in our tests due to data limitations in the derivatives reporting in the annual reports may introduce noise to our test; however, there is some evidence that ? rms ? rst net positions in the same currency before aggregating them. In other words, a long yen and a short yen forward position will ? rst be netted out.
Note also that our hypothesis predicts a relationship between the absolute value of derivatives and the absolute value of exposure; that is, a higher level of derivatives should be associated with a lower level of exposure in absolute value, if derivatives are used for hedging. Therefore, the lack of a sign in the derivatives data due to reporting limitations should not introduce any speci? c systematic bias. Also, to the degree that there are other sources of exposure, direct or indirect that are omitted in the regression, this would cause bias towards insigni? cance. Therefore, our ?
Again, we ? nd that exposure through foreign sales is positively and signi? cantly related to a ? rm’s decision to issue foreign debt and to the level of foreign debt. Overall, these ? ndings are consistent with our hypothesis that ? rms use foreign debt to hedge their exchange-rate exposure. The paper is organized as follows: Section 2 describes our sample; Section 3 presents the tests of the relation between exchange-rate exposure and foreign currency derivatives; Section 4 presents the tests on the use and amount of foreign currency derivatives; and Section 5 concludes. 2.
The Term Paper on General Motors Competitive Exposure
1. INTRODUCTION General Motors is a large multinational enterprise with operations in more than 200 different countries. It is an American multinational automotive corporation headquartered in Detroit, Michigan and the world’s largest automaker (2001). It employs 365,000 people in every major region of the world. It produces cars and trucks in 30 countries, and sells and services these ...
Sample description SFAS 105 requires ? rms to report information on ? nancial instruments with offbalance sheet risk (e. g. , futures, forwards, options, and swaps) for ? scal years ending after June 15, 1990. In particular, ? rms must report the face, contract, or notional amount of the ? nancial instrument, and information on the credit and market risk of those instruments, the cash requirements, and the related accounting policy. With the exception of futures contracts, disclosure was very limited for other off-balance sheet risk ? nancial instruments prior to SFAS 105.
We obtain data on year-end notional value of forward contracts reported in the footnotes of the annual reports of all the S&P 500 non? nancial ? rms in 1993. We exclude S&P 500 ? nancial ? rms, because most of them are also market-makers in foreign currency derivatives; hence, their motivation for using derivatives could be very different from that of the non? nancial ? rms. Our sample’s notional values of foreign currency derivatives also include foreign currency options, if a ? rm disclosed a combined number. However, these values do not include foreign currency swaps.
Currency swaps are mainly used by corporations in conjunction with foreign debt, effectively translating foreign debt into domestic liability. In the Bodnar et al. (1995) report of a survey on the use of derivatives of a large sample of US non? nancial corporations, the instrument used by 48% of the ? rms in the sample to manage exchange-rate risk was forwards. Using the dollar notional value of foreign currency derivatives has several advantages over using a binary variable to indicate whether or not a ? rm uses foreign currency derivatives.
For example, by using this continuous variable, we can test hypotheses on the determinants of the amount of hedging and examine the impact of a ? rm’s currency derivative use on its exchange-rate exposure. However, a disadvantage of this measure is that since ? rms were not required to disclose the direction of the hedge during the period of our tests, we do not know whether the amounts of foreign currency derivatives represent a short or a long position in the underlying currency. This drawback in the data should not introduce any speci?
The Essay on Currency Hedging Exchange Rate
What is hedging? Hedging is a strategy used to protect risks posed by worldwide currency fluctuations. One hedges the currency risk by contracting to sell foreign currency in the future, at the current exchange rate (Fries). If fund managers think the dollar is going to be stronger when they are ready to change the foreign currency back into American dollars, then they take out a foreign futures ...
Hence, our hypothesis suggests that exchange-rate exposure should be positively related to the ratio of foreign sales to total sales. 7 For theoretical models predicting this relation between a dollar appreciation and an exporter’s/importer’s value, see e. g. , Levi (1993) and Shapiro (1975).
280 G. Allayannis, E. Ofek / Journal of International Money and Finance 20 (2001) 273–296 On the other hand, if ? rms use foreign currency derivatives to hedge against exchange-rate movements, then the use of derivatives should reduce their foreign exchange exposure. That is, the use of derivatives should decrease exchange-rate exposure for ?
We cannot hypothesize any relation between the absolute value of foreign currency exposure and the ratio of foreign sales to total sales, or between foreign currency exposure and (absolute value of) currency derivative used. Table 2 presents the coef? cient estimates of model 2, which links a ? rm’s exchange-rate exposure (estimated from model 1) with its determinants, namely the percentage of foreign sales and the percentage of foreign currency derivatives used. In the ? rst regression (? rst column in Table 2), we consider all exposures, both positive and negative.
Consistent with our hypothesis, we ? nd a strong positive relation between exchange-rate exposure and the ratio of foreign sales to total sales. In the second regression (second column in Table 2), we examine the relation between exchange-rate exposure and ? rms’ foreign currency derivative use, using the absolute value of the exposures. Consistent with a ? rm’s hedging motive for the use of foreign currency derivatives, we ? nd a negative, statistically signi? cant Table 2 FX exposure and the use of derivativesa,b Sample Dependent variable All ? rms Predict b2 Observations R2 Intercept
We perform several additional tests on the sample of positive exposures to examine the robustness of our results. First, we examine whether our results depend on the three-year time interval (1992–94) that we use to estimate ? rm exposures. We therefore estimate exposures using a longer (? ve-year) time interval (1991–95).
The Essay on The Story of Foreign Trade and Exchange
For example, because of differences in soil and climate, the United States is better at producing wheat than Brazil, and Brazil is better at producing coffee than the United States. Obviously both countries are better off when Americans produce wheat and exchange a portion of it for some of the coffee that Brazilians produce. But does this mean that a country with an absolute advantage in the ...
Regression 1 in Table 3 presents the results of this test. The results are very similar to those of the base-case regression (Regression 3, Table 2).
Consistent with our hypothesis, we ? nd a positive and signi? cant relation between foreign sales and exposure, and a negative and signi?
However, the choice of index does not affect our results (Regression 2, Table 3), since the use of derivatives (foreign sales) is also signi? cantly negatively (positively) related to a ? rm’s exchange-rate exposure estimated based on the Dallas Fed exchange-rate index. 8 We obtain similar results when we use White-adjusted errors. Our results also do not change, when we eliminate.
We present the estimates (top) and the corresponding t-statistics (bottom) for the intercept a1i, the coef? cient of the ratio of foreign sales to total sales, a2i, and the coef? cient of the ratio of foreign currency derivatives to total assets a3i, for the cases in which we estimate exposure. We use a ? ve-year interval (Regression 1), an alternative exchange-rate index (Dallas Fed RX-101) (Regression 2), the S&P 500 ? rms that report currency derivative data in their 1992 annual reports (Regression 3), and for two alternative estimation techniques.
The results, presented in Regression 4, remain unchanged. Again, consistent with our hypothesis, the use of currency derivatives signi? cantly reduces a ? rm’s exchange-rate exposure. Finally, we re-estimate model 2, using a probit estimation, in which the dependent variable is a binary variable which equals one if a ? rm’s exposure is statistically signi? cant at the 10% level, and zero otherwise (Regression 5, Table 3).
This procedure could be viewed as an extreme weighting scheme under which only statistically signi? cant estimates are considered.
