| Pub. Date | : April, 2023 |
|---|---|
| Product Name | : The IUP Journal of Applied Finance |
| Product Type | : Article |
| Product Code | : IJAF010423 |
| Author Name | : Sangeeta D Misra |
| Availability | : YES |
| Subject/Domain | : Finance |
| Download Format | : PDF Format |
| No. of Pages | : 32 |
To safeguard against foreign exchange risk due to high market volatility in today's globalized world, exporters use currency futures and options for smoothening the cash flows. This paper aims to analyze the performance of hedging foreign exchange risk using US dollar futures and options and their characteristics. The study uses data from 2016 to 2022. The results show that Indian exporters with a relatively high degree of risk aversion should prefer USD futures contracts with long-term maturities, low liquidity, and high open interest to hedge foreign exchange risk and generate maximum benefits in value enhancement. On the other hand, Indian exporters with a relatively low degree of risk aversion should use the protective put strategy with put options characteristics of long-term maturity, high liquidity, and out-of-the-money (in-the-money) put options if they have a strong conviction about the rising (declining) USD market. The results are robust as they are consistent for all individual years from 2016 to 2022 and for the overall period too.
In today's globalized world, the foreign exchange market has become highly volatile (Meese,
1990). In response to the highly volatile foreign exchange rates, multinational companies
pay a lot of attention to the fluctuations of foreign exchange rates (Rawls and Smithson,
1990). To smoothen out the cash flows, the use of currency derivatives has become a regular
practice (Bodnar et al., 1996 and 1998; and Bodnar and Gebhardt, 1999).
Many studies have analyzed the impact of hedging foreign exchange risk on firm value.
Nain (2004) reported that firms that do not hedge foreign exchange risk have a value 5%
lower than those that hedge foreign exchange risk using currency derivatives. Similarly,
Allayannis and Weston (2001) found that firms that hedge foreign exchange risk using
currency derivatives have a firm value 5% higher than firms that do not hedge foreign exchange
risk. The other major studies that have analyzed the use of currency derivatives on firm value
are Guay and Kothari (2003) and Bartram et al. (2011). Bae et al. (2018) reported that Korean
firms with high foreign exchange exposure use more currency derivatives to hedge foreign
exchange risk.
An exporter or an investor who is expected to receive foreign currency on some specified
future date may be worried that the value of the foreign currency may decline in the future,