Determinants of Exchange Rate Exposure: A Study of Indian Firms

Abstract

Exchange rate exposure is the uncertainty created by the unintuitive movement in the exchange rates between the currencies. The findings of the previous studies revealed that the changes in exchange rate affect the firm value. Hence, understanding exchange rate exposure is important for both managers and the investors. This thesis attempts to answer three research questions. First, does the movement in the exchange rate affect the value of the firm? Second, what are the factors determining the exchange exposure of a firm? Third, what are the strategies used by the Indian firms to manage the exchange rate exposure? The sample of 387 non-financial firms listed in the National Stock Exchange is studied for a period of five years from 2011-12 to 2015-16. The exchange rate exposure of the firms was estimated using capital market model and cash flow model. The empirical results of this study indicate that stock returns of over 68 percent of the firms were significantly exposed to the changes in the exchange rates. The study reveals that the exposure of net importing industries such as Energy, Chemicals and Fertilizers was greater compared to the other industries. While the net exporting industries such as Information Technology and Pharmaceuticals exhibited the least exposure to exchange rate changes. The study argued that the exchange rate movements have a higher effect on the value of the firms with higher level of financial distress. The results supported this argument. The study provides evidence that the firm size, depth of international presence and hedging are the significant determinants of the exchange rate exposure. The influence of factors such as breath of international presence, liquidity, profitability and foreign currency borrowing was found to be insignificant. The survey of the hedging techniques used by the sample firms reveals that currency forwards are the most preferred currency derivative for hedging. The exchange traded products such as currency futures and currency options were used less frequently. Cross currency interest rate swaps were used to hedge the long term liabilities.