Page 112 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

Unit 7: Management of Transaction Exposure

(48.8 per cent). Such recent innovations as compound options (3.8 per cent) and lookback options Notes
(5.1 per cent) were among the least extensively used instruments. These findings seem to indicate
that most US firms meet their exchange risk management needs with forward, swap and options
contracts.

Table 7.1: Risk Management Products

Type of Product Heard of (Awareness) Used (Adoption)
Forward contracts 100.% 93.1%
Foreign currency swaps 98.8 52.6
Foreign currency futures 98.8 20.1
Exchange traded currency options 96.4 17.3
Exchange traded futures options 95.8 8.9
Over-the-counter currency options 93.5 48.8
Cylinder options 91.2 28.7
Synthetic forwards 88.0 22.0
Synthetic options 88.0 18.6
Participating forwards, etc. 83.6 15.8
Forward exchange agreements, etc. 81.7 14.8
Foreign currency warrants 77.7 4.2
Break forwards, etc. 65.3 4.9
Compound options 55.8 3.8
Lookback options, etc. 52.1 5.1
Average across products 84.4% 23.9%
Source: Kurt Jesswein, Chuck Kwok, and William Folks, Jr, “Corporate Use of Innovative Foreign Exchange
Risk Management Products,” Columbia Journal of World Business.
The Jesswein, Kwok, and Folks survey also shows that, among the various industries, the
finance/insurance/real estate industry stands out as the most frequent user of exchange risk
management products. This finding is not surprising. This industry has more finance experts
who are skillful at using derivative securities. In addition, this industry handles mainly financial
assets which tend to be exposed to exchange risk. The survey further shows that the corporate
use of foreign exchange risk management products is positively related to the firm’s degree of
international involvement. This finding is not surprising either. As the firm becomes more
internationalised through cross-border trade and investments, it is likely to handle an increasing
amount of foreign currencies, giving rise to a greater demand for exchange risk hedging.

7.4.1 Currency Correlation and Variability as Hedging Tools

The degree of simultaneous movements of two or more currencies with respect to some base
currency is explained by currency correlations. The correlations among currency movements
can be measured by their correlation coefficient which indicates the degree to which two currencies
move in relation to each other. This information can be used by MNCs not only when deciding
on their degree of transaction exposure but also in the determination of movement of exchange
rate of foreign currencies. In analyzing the concept of currency correlation, MNC’s keep in mind
that currency correlation are not constant over time and that they cannot use previous correlation
to predict future correlation with perfect accuracy. While temporary shocks/disturbances in an
economy may cause an appreciation or depreciation of a specific currency without there being

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