Determinants of Hedging FX risk Survey of EU - Free Essay Example

Sample details Pages: 12 Words: 3670 Downloads: 5 Date added: 2017/06/26 Category Finance Essay Type Argumentative essay Did you like this example? Hedging as defined by Judge (2006) is all tools and techniques used to Minimise Risk, these tools and techniques include use of Derivatives like Swaps, Forwards Contracts, Asset Liability Match and etc. Further Hedging can be considered to be similar to Medicine i.e. shall be used with the purpose to minimise risk however it was found that there can be different possible use of Hedging Currency risk as found in Graham and Rogers (2002) that one of the different use of Hedging can be to escape Tax, the working behind that was explained that Hedging Risk via raising debt will reduce the Tax and will improve the Debt capacity along with the Firm Value. Don’t waste time! Our writers will create an original "Determinants of Hedging FX risk Survey of EU" essay for you Create order Also to note that Smith (1995) found that some part of Corporate Hedging include Hedging with a motive to earn profit and not to minimise risk. 1.2 Background : Recent currency Appreciations and then the Depreciation resultant of The Greece scare of the government being insolvent did cause a lot of instability to the currency market as far as the Euro is concerned. The automobile industry in the world has most EU country producers, Germany being one of the biggest producers as it had producers like Daimler, Mercedes, BMW and Porsche and Italy has Ferrari, Jaguar from England and many more. This companies sell all over the world, hence this exposes them to a foreign currency risk which in turn might want the companies to minimise these risks as well. (Yahoo! Finance Graph) Taking into consideration the US Dollar which is the worlds most traded currency against Euro. The above graph suggest that the Euro was stronger against the USD as the result of huge amount of cars being imported in USA, further the current contagion effect of the Greece government the Euro has fallen and has affect some of these companies. As reported by Reed, J. (2007) that the weakening of USD has hurt the giant car manufacturer which meant that Appreciation as seen in the graph initially did hurt the BMW and so will to many more similar companies. This means that a appreciating currency company when sales its product in a country where the currency is depreciating the company will suffer lose of lower profits. Hence comparison found in the report to a similar producer i.e. Daimler that reported return on sales was 9.5 % compare to BMW 5.4 % CONTINUE. Now there are a number of ways a firm can save the losses caused by currency movements, some of them are use of Forwards, Swaps an d etc Derivatives another option is that to create a natural hedge i.e. to create an Asset Liability match as explained by Judge (2006). Some firms which have huge demand and can afford a production unit like BMW can make a production unit in Free trade Zone with in the allowed parts of Mexico near USA and then reduce the cost and hence eliminate risk. Further as suggested by Judge (2006) that while findings determinants of Hedging the past literature explains quite a bit however the answer still remains a Mystery , similarly it was found in Rogers and Graham (2002) they said in reference to the research that Hedging depends on the industry and market drivers however for Auto mobile car industry there has been no ideal method to deal with foreign exchange exposure. 1.3 Research Question : To see if there is any significant effect of currency appreciation or depreciation on the Auto Mobile car Industry in EU. In the case of Significant effect how does the company Hedge i.e. does the company outsource its production in-order to reduce or eliminate the effect of currency meaning a natural hedge or a company uses derivatives. The most important objective is to see that if there is any ideal solution that is being used in within the industry. 1.4 Hypothesis : All the hypothesis will be tested step by step, this means that H1 will be tested first and then H2 and so on. The alternative hypothesis is simply the other possible thing for instance for H1 the alternative Hypothesis i.e. HA will be Currency change has no effect on the companies in the Auto Mobile Car Industry. H1 : Currency changes has an effect on the companies in Auto Mobile Car Industry H2 : The companies do Hedge H3 : The companies do a nature Hedge i.e. an Asset Liability match H4 : The companies Hedges with the help of Derivatives 1.5 Research Aims and Objectives : Aims : One of the main aim of the research is to learn what is the general idea if any within the Automobile car Industry, however if in case of a common practice what shall be the rationale of the common practice is an important question. Further if there are no similar practices the rationale of different practices is at core importance of the study. Objectives : The first and the most important task is to review the list of similar researches done in the past, then comes the plan of an ideal analysis technique to be used taking into consideration the data availability / requirement. After the technique has been decided the required data will be collected and analysed, here there can be problems like Unbalanced Data problem as found in Judge (2002a). The problem with unbalanced data is that data for some type is missing hence shall be removed or be balanced in order to finish the analysis. And to end with after overcoming the problem of unbalanced data the analysed data will be interrelated and interpret in the authors own view and ideas. 1.6 Literature Review : Starting from Bua et al. (2009) explained currency hedging in relation to cost concept, the main aim of the research was to explain the cost concept that is conflicting with the returns on hedging however the main aim or rationale of hedging is to minimise risk but the research revolves around two other reasons of hedging i.e. Value creation and other reasons like being risk averse, or using hedging as the last resort of reducing the risk. Further the paper then goes on to explain the evidence on Hedging from Auto mobile car Industry in US and Europe. It was found out of 273 companies examined that had foreign exchange exposure, those were specifically Auto mobile car companies i.e. car makers or the engine makers or luxury interior designing firms for luxury cars, the data used was to know if the companies did hedge and if they did what was the method. The way of analysis i.e. the methodology used was a multiple factor regression the factors included Capital structure, nominal value s of the derivatives, sales (foreign and domestic), and etc. The findings of the result were further supported with a significance test to confirm if the results were meaningful. Finally the conclusion of the report was into two parts the first part of the conclusion was found that cost of hedging has a significant effect on value creation i.e. as per the theory as the cost of hedging increases the profits from the same will reduce however this will give rise to value creation if the hedge is a nature hedge i.e. an assets liability match. Hence it was concluded that an asset liability match is a better way to hedge if the company has a significant amount of sales in foreign and does report to historical price standard for the annual reports, further the other half i.e. the important half explained that for Auto mobile car Industry it was found that companies with significant car sales for instance Jaguar, BMW, Mercedes and etc were found to be using swaps for smaller hedges and for bigger hedges the most profitable i.e. the most viable option was an Asset liability match followed by forward contracts to report in the home currency. An interesting bit noted in the research was that there was no clear explanation of a rule of thumb to hedge for Auto mobile car companies and was concluded that the research still leaves A lot of work to be done yet. Further in a similar research by Judge (2006) was about what determines the hedging of foreign currency hedging by non financial firms in within the UK. The author argues that there is a relationship between Financial distress costs like interest on shares and debentures over the hedging decision i.e. totally related to Asset Liability match. It was also found that the findings were also significant with the US data that was analysed and concluded in different studies but the author argues that this might be a biased result as the data collection explained internet only and derivatives hedgers and nothing else i.e. a n arrow or result tied to a specific hedgers. Further the author explained that determining the factors leading to Hedging can include factors like Hedging for Tax Incentives, Cost of Financial Distress as found in Bua et al. (2009) alongside Graham and Rogers (2002). Further the determinants or the factors determining Hedging included Under investment costs i.e. in case of a companys globally recognised will have a better effect on a investor then a domestic company, another and one of the most logical and important factor to be considered was the amount of foreign exposure i.e. the amount of sales or the amount of cash flow generated from foreign country. Talking about the sample that was of 500 and 441 were non financial companies as on December 1995 but only 412 firms were selected to analysed i.e. for the analysis. The author used Multivariate Regression Analysis to test the data as it can include a number of variables that can be considered. Further the conclusion found was tha t there is a strong significant relationship between foreign currency hedging and financial distress costs like debenture interests and etc. Further another factors to be considered is a foreign debt, as found in Judge (2002) that about most of studies that were taken into consideration particularly in relation to the use of foreign debt found that use of foreign debt is now getting on to be a very good option for counties that have cash flow from the same foreign country, the hedge works in a way that the cash flow is settled against the distress cost arise in the country by raising the debt. This will create a hedge with number of advances i.e. increase the firm value as explained in Judge (2002) and Bua et al. (2009) reduce the distress cost hence by offsetting it against the cash flow and the most important one will be there will be no foreign exchange risk to the cash flow as it will then be settled in within. Further banks considered to be an institution that does hedging for different companies i.e. that is what banks are meant to be for, a research by Sinkey and Carter (1994) tried to explain the use of derivatives and hedging activities by Banks in within the United States the rationale was explained that banks do both deal and use it for hedging as well. The preposition of dealing with derivatives and using the same for hedging are not always the same with every bank some banks can do it and some cannot hence it was found that out of 11000 banks only 600 did both together. For banks out of the sample of 600 , the analysis were done using multiple regression similar to the above researches i.e. Judge (2002) , Bua et al. (2009) and Graham and Rogers (2002) as well. The conclusion of the research however was that there is a correlation between banks having weaker capital structure and hedging, low margin of profits and deteriorating asset management further it was found that with banks the determinants for hedging were not only for risk management howev er profit motive was considered to be an extra measure of hedging. To so sum up almost every research reviewed it was found that hedging is meant for risk management however it shall be noted that not many hedge funds manage to earn profit or super normal profit and the reason to that can be that they are not meant for profit. The ideal hedging mainly found are an asset liability match and raising foreign debt is considered to be a good example of hedging for companies with health amount of foreign operations. The determinants found were significant amount of sales in foreign country or currency, a widely operating company i.e. operations in different country, and etc. 1.7 Rationale of Research : Personal Reason : I am very much interested in Foreign currency Exchange literature, recent fluctuations in the currency market has made me keen about many factors that affect the movement of currency and one of them is import and export. Being a student I can explore a area of FX markets and determine the factors of hedging. Further the Automobile industry in EU is the biggest and best in the world which made me passionate about the research. Academic Reason : Being a student I am very keen to learn about FX market and to explore new areas of Hedging as well and for that this research will be perfect for me. 1.8 Reflection : The reflection of the research is that all the empirical research will be carried out with a greater care that is does not provide biased results. The ethical implication however that is there is no use of primary data hence it can be assumed that there is no problem. Further all the data that can be analysed are from different data source i.e. companies own annual report. 1.9 Scope : The scope of the study is for Hedging the Foreign risk that is limited to Auto mobile car industry in The European union. Further taking other factors into consideration it was found that if in case of a narrow model being formed it can be criticised in number of ways i.e. selection of model and selection of the different processes. 1.10 Action Plan : The main rationale of the research is to clear he fume that has been around the research literature reviewed and it was found that all the research has concluded that the research stays a bit handicap hence to conclude on the part of what can be a better way of hedging for auto mobile car industry in Europe. There are a number of things to be considered is the data availability i.e. in some cases companies report throughout a number of years and some times the reporting standard keeps on changing hence it is to be considered that an unbalanced data will be taken into consideration but care will be taken that it does not create any biases. Date Target 18th February, 2011 Introduction 25th February, 2011 Literature review 15th March, 2011 Data collection 23th March, 2011 Data Analysis 28th March, 2011 Data interpretation 15th March, 2011 Conclusion The tasks will be kept on till the research is finished, the first task will be to review the literature i.e. similar in terms of topic or similar in terms of Method this shall be done by 25th February, 2011., the second step will be data collection which shall be finished by the 15th of March, 2011., then taking into consideration full data support the analysis will be carried out and the interpretation will be done by 28th of March, 2011., and to end with the conclusion and finishing up activities will be done by 15th of April, 2011. 1.11 Ethical consideration : All the work presented will be original hence the code of ethics will be taken into strict consideration, all the work that has been used from other articles or resources have been marked and referenced properly. 1.12 Methodology : Taking into consideration number of surveys i.e. Literature review into consideration it was found that under most cases it was found that Multiple regression was considered to be the finest method to conclude, the justification found was that authors thought that a multiple regression model can include a different variety of factors also it is possible to include a dummy which is quiet possible in the current analysis to differentiate the different types of companies i.e. to narrow down the selection. Further all the regression analysis will be backed by a significance test as found in Judge (2002) and Graham and Rogers (2002). 1.13 Research Design : The data to be used in the analysis is purely secondary data. The data will be collected from the official site of a company or the annual reports, with annual reports it is clear that the report is published under high audit programmes. Under collection of the secondary data the only possible problem is that the data turns out to be an unbalanced data and balancing data may create biasedness however care will be taken so that the data is not wasted. 1.14 Analysis and Discussion : The collection of data will start with collection of annual reports i.e. Secondary audited data will be used, the data will then be extracted out of the annual reports like if the companies hedge, type of capital structure, derivatives used by them and etc. The analysis of this data will be done after refining the data i.e. converting the data t a value that will be similar for all the companies hence to do the analysis is easy. However care will be taken that in this process the data do not turn biased or are not manipulated in order to get a desired result. The analysis will be done using a statistical software called Stata 11 .0 v. The software will give out a result that can be used and understood by researchers under most cases hence the data so analysis via Stata 11 .0 v will be presented in a simple table format and interpreted in a manner that it is easy even for the layman to understand the interpretation and the analysis. Finally the methodology so used is a multi regression analysis; the regression will include those variables that have been significant in the past research hence to get a better result. There can be two critical part in the analysis the first part can be explained as a technical part as it is a Panel data analysis there are a number of statistical problem with the data that cannot be ignored however if this problems are then taken into account the problem with them is the analysis will be too long to conclude also then the analysis will be more technical then it will be less related to the main topic of Hedging in the automobile industry. The second part is related to the topic as it is a topic related to Hedging the topic has been narrowed to Auto mobile with the rationale that the research produces a fair and industry specific analysis. However this narrow bit can be considered to be critical, as the analysis will be down to only on industry or sector. 1.15 Implementation of Research project : The research method involves some procedures to be followed as seen in the past research however care will be taken that the research follows as missing a part of the procedure can be a critical problem. With hypothesis testing and research question the above method will be followed i.e. taken from researches taken into literature review however to specify the applicability or the validity and reliability will be tested by a statistical method called Test Statistics which will be found by a formula and will be compared to table value of the frequency that follows a T distribution. 1.16 Research Evaluation : The success of the research on the basis of the data gathered and rest on the availability, the thing with the data is that because all the companies have different reporting techniques it is hard to find the required data, also to note some companies will be French, Italian, German and etc, this companies will mostly report in their national language hence sometimes this companies make the English version of the annual report available however if the annual report is unavailable in English the company then has to be ignored in the research and if the problem is similar with more number of companies the analysis may suffer as the sample then get reduced and might produced a biased or narrow result assuming that the companies ignored will not make much difference. Reliability of the research is depend on the supervisors signature i.e. the research will be supervised by a expert in the field hence this will enable the research to be signed by an authenticated person who knows more about the field then the researcher. However the supervisor will have to keep an eye that the research is not manipulated. The advantage of the research will be to 3 types of people, firstly the advantage will be to these companies examined as the result will then suggest them and evaluate the their own strategies. The second advantage will be to the government, this will suggest to the government that how auto mobile companies hedge, because hedging itself contains risk the government has to keep an eye as a watch dog that the companies are not misusing the method of hedging hence the government after looking at the research can know if the market is safe i.e. the share holders are safe or not and this will give rise to any change that has to be done or not. Further the third advantage of the research will be to foreign exchange traders to derive the current market flow of hedging, hence if there are news about the auto mobile industry the foreign exchange traders then know how the markets shall react and hence this research and its findings will help them decide how to trade. 1.17 Conclusion : Finally it can be concluded that taking into consideration the clarity of thoughts, ideas and data collection technique the research can be completed with in the given period of time or the time frame designed, however certain barriers may obstruct the way but then depending upton the barrier the problems will be solved and taken further.