Foreign Currency Hedging Case Study

1361 Words 5 Pages
2.1 Introduction
In this chapter, previous literature concerns with the determinants of foreign currency hedging will be discussed and assessed.
Theories for the determinants of foreign currency hedging can be evaluated from two aspects: the level of foreign exchange exposure and how firm’s value will be affected; what kinds of characteristics for the firm influence its decisions for hedging. I will discuss the determinants of foreign currency hedging from this two points of view in the following sections.
Multinational corporations (MNCs) involve in foreign currency hedging activities because of their foreign exposures will have an impact on its expected cash flows. The determinants of foreign currency exposure should be consistent with factors
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The theories of risk management have been developing for a long period, the aims for hedging is changing over time. Modigliani and Miller (1958) argue that hedging do not change the real value of firms in a perfect capital market, but Sultz (1996) state that hedging reduces the cost of financial distress to create comparative advantages and most firms prefer to hedge selectively.
There are many determinants of foreign currency hedging: the cost of financial distress, the cost of underinvestment, tax function convexity, economies of scale and managerial risk averse. In this, various hedging determinants will be discussed in theory that what are the theoretical impacts, and also summary the results of previous empirical studies for each factors.
For the purpose of this study, foreign currency hedging in Hong Kong is the main focus. Theories for foreign currency hedging can be applied to different markets, but it is necessary to take some specific characteristics into consideration. Hong Kong market has its speciality and it is significantly being influenced by government currency policies and literatures in Hong Kong will be one of the main discussions of this
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Multinational corporations (MNCs) usually have some operations or transactions outside their home country, so they may have to deal with many foreign currencies on a daily basis. A firm’s foreign currency exposure can be determined by its many characteristics such as foreign operations, firm size or fluctuation of share price. A study of Pantzalis et al. (2001) examines the relationships between many variables and foreign exchange exposure including operational hedging. They find that foreign sales or involvements are most significant influencing factors for foreign currency exposure, more foreign operations in a firm usually accompanied with higher foreign currency exposure; firm size only have some week positive effects on the FX exposure; the volatility of share price also positively related to exposures of foreign currency

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