Article Summary

Exchange-Rate Exposure of firms and workers

Exchange-Rate Hedging: Financial vs Operational Strategies

Usman Riaz























The paper investigates the role of financial and operational hedging in creating
shareholders value. The authors take a sample of 256 US multinational non-
financial companies. The paper concludes that operational hedging is not a
substitute for financial hedging. They can complement each other but operational
hedging cannot be used alone as a substitute for financial hedging. Firms that are
geographically dispersed are more likely to use financial hedging.
A regression analysis is done by the authors. The four proxies for operational
hedging that are used are:
1. No. of countries in which it operates
2. No. of broad regions in which it is located
3. Geographic dispersion of its subsidiaries across countries
4. Geographic dispersion of its subsidiaries across regions.
To calculate the effect of operational hedging on exchange rate, a two factor
model is used keeping the return on stock as dependent and the market return
and exchange rate index independent.
A significant negative correlation was found between financial hedging and
exchange rate exposure. This means that financial hedging decreases the
exchange rate risk.
A regression analysis is performed with exchange rate exposure and 3 variables. A
dummy variable representing the financial hedging ( 1 for using hedging, ) for not
using it). Second is the operational hedging and last is the percentage of total
forign sales.
The findings of the analysis were that there is a negative and significant relation
between the financial hedging and exchange rate exposure. This meant that
companies that are exposed to exchange rate risk use currency derivatives and
foreign debt to minimize risk. Other coefficients suggested that there was a
positive relation between operational hedging and the exchange rate exposure.
This meant that companies that do operational hedging increase the exchange
rate risk. This clearly suggests that operational hedging is not a substitute for
financial hedging. So the findings can be summarized as the more the dispersed a
company and the more foreign sales, the more is the need for financial hedging.
The next step performed by the authors was to test how good both financial and
operational hedging worked and how did it increase share holder value. The
market to book ratio is regressed with foreign sales percentage and the proxies
used earlier. The results proved that the coefficient of foreign sales is negative
and significant, which means that the more a firm has foreign sales unhedged, the
more the market value will decrease. This means less people would invest in the
company. The correlation between operational hedging and firm value is low
suggesting that operational hedging doesnot increase firm value. But if a company
uses both financial and operational hedging together, it can improve the
shareholder value. This is given by the positive significant coefficient of the firm
value and the interaction term.
Conclusion
Geographically dispersed firms need to use financial hedging more due to the
level of echange rate exposure they experience. Firm value is not affected by
operational hedging but if it is used with financial hedging, firm value is increased
substantially.