1 ABSTRACT This paper examines the foreign exchange exposure of UK non-financial listed companies over the period January 2005 to December 2010 and compares to two sub periods - pre-recession period (2005-2007) and recession/post-recession period (2008-2010). The Jorion (1991) model is used to estimate the exchange rate exposure - change in exchange rate is regressed on firms’ abnormal returns. The findings reveal no supporting evidence for a contemporaneous relationship over total sample period and recession/post-recession sub period but the existence of a contemporaneous relationship during the pre-recession sub period cannot be rejected. Given the change in economic conditions around the recession period (the year 2008 is chosen as the break point) The analysis may be beneficial to financial managers in formulating hedging strategies, as hedging requires additional cost along with forgone profit if hedging is not the optimal decision, when faced with favorable/adverse economic conditions. This study may also be beneficial for investors to make informed investment decisions. Keywords: Exchange-rate, Exposure, non-financial, Recession, Abnormal returns With the adoption of a floating exchange rate regime and rapid globalization – firms constantly attempt to look for new investment opportunities and markets beyond their immediate borders which account for the increasing exposure of firms to foreign exchange risk in recent times (Zubeiru et. al, 2007). The adoption of floating exchange rate regimes by many industrialized countries during the 1970s heralded a new era of increased exchange rate volatility (Abdalla and Murinde, 1997) which acted as a major source of macroeconomic uncertainty affecting firms (Asaolu, 2011). The frequent changes in foreign exchange rates is of prime concern to firms, financial analysts and economists due to their effects on firm operations, revenues and valuation. Exchange rates can also have an impact on a firm’s level of competitiveness due to its exposure to exchange rate risk (El-Masry et al., 2007). Due to exchange rate exposure a company’s competitive profile may alter considerably and result in a loss of market share or reduced profit margins (Dhanani and Groves, 2001). Furthermore, firms without foreign revenues, costs or operations might be indirectly affected
2 by exchange rate changes through their impact on foreign competition or broader macroeconomic conditions (Parsley and Popper, 2002). Hence, persistent exchange rate volatility and the increasing globalization of businesses make foreign exchange exposure management a key component of corporate strategy (Booth and Rotenberg, 1990) and given the difficulty in anticipating exchange rate movements, corporate managers, investors devise means of investing or managing optimally to neutralize exchange rate risks (Zubeiru et. al, 2007). Therefore for managers, creditors and investors alike the challenge is then to accurately assess the magnitude and impact of foreign exchange exposure as it is important to assess the problem first before it can be managed (Booth and Rotenberg, 1990). This paper is
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