Currency Exposure and Hedging Practices among Indian Non-financial Firms

Date01 August 2014
Published date01 August 2014
Subject MatterArticles
Currency Exposure and
Hedging Practices among
Indian Non-financial Firms:
An Empirical Study
Praveen Bhagawan M.
P.J. Jijo Lukose
This article investigates the exchange-rate exposure of S&P CNX 500 non-financial
constituents during 2006–2011. By using a standard two-factor market model, we
measure the sensitivity of stock returns to changes in the exchange rate and find that
11 per cent of sample firms are significantly exposed to exchange-rate fluctuations.
Further, we empirically evaluate the impact of hedging strategies adopted by our
sample firms on the exchange-rate exposure. Our evidence suggests that the usage
of foreign currency derivatives and foreign currency debt significantly reduces firms’
exchange-rate exposure. Smaller firms appear to have lower levels of exchange-rate
exposure as compared to larger firms. A significant negative relationship between
exchange-rate exposure and foreign currency derivatives supports the hypothesis
that firms use foreign currency derivatives for hedging and not for speculative pur-
poses. These results are found to be robust to alternative ways of measuring foreign
currency exposure, exchange-rate indices and estimation methods.
JEL: G3, G32, F3
Exchange-rate exposure, hedging, currency derivatives, risk management
The large volatility of the exchange rate has become a major source of risk to Indian
firms since the introduction of the managed float exchange-rate system in March
1993. In the ‘managed float’ exchange-rate system, Reserve Bank of India (RBI)
Foreign Trade Review
49(3) 247–262
©2014 Indian Institute of
Foreign Trade
SAGE Publications
Los Angeles, London,
New Delhi, Singapore,
Washington DC
DOI: 10.1177/0015732514539202
Praveen Bhagawan M. (Corresponding Author), Ph.D. Scholar, Institute for Financial
Management and Research, Chennai, Tamil Nadu, India. E-mail: praveenbhagawan@
P.J. Jijo Lukose, Associate Professor, Indian Institute of Management, Tiruchirappalli,
Chennai, Tamil Nadu, India. E-mail:
Foreign Trade Review, 49, 3 (2014): 247–262
248 Praveen Bhagawan M. and P.J. Jijo Lukose
intervenes in the currency market to curb the volatility of exchange rates but does
not promise a specified rate of conversion for foreign currency. Moreover, the eco-
nomic reforms of 1991 have led firms to operate in a globalized economy with more
opportunities and risks. The Indian export of goods (import of goods) have increased
from US$22,238.30 (US$23,306.20) million in the financial year 1993–1994 to
US$2,51,136.20 (US$369,769.10) million in 2010–2011.1 Indian cross-border
mergers and acquisitions of purchaser (seller) have increased from US$138.479
(US$90.112) million in 1994 to US$6,071.993 (US$12,576.563) million in 2011.2
All these factors have forced Indian firms to change their hedging strategy with
regard to exposure arising from exports, imports, and cross-border mergers and
acquisitions. This article answers three economically important questions relating to
currency exposure and relationship between firms’ hedging strategies and exchange-
rate exposure using Indian dataset and contributes to the empirical literature on
exchange-rate risk and risk management from an emerging market. First, we exam-
ine whether there is any significant relationship between firms’ stock returns and
fluctuations in exchange rates by considering the non-financial constituents of S&P
CNX 500 for the period from April 2006 to March 2011. Second, we document the
strategies used by sample firms in managing the exchange-rate exposure by manu-
ally collecting disclosures from annual reports. This dataset helps us to overcome the
limitations of existing studies on risk management which owing to the paucity of
data on firm-level hedging strategies are mostly descriptive. Third, we examine
whether the usage of currency derivatives significantly reduces the exchange-rate
exposure of the sample firms. This helps in validating whether firms use currency
derivatives for hedging or for speculative purposes.
Using a standard two-factor model, we find that 11 per cent of the sample firms
are exposed to exchange-rate risk. Further, this sensitivity varies in terms of mag-
nitude and direction across sample firms due to the heterogeneous nature of the
firms. In addition, the results imply that firms are able to reduce their exchange-
rate exposure with foreign currency derivatives, foreign currency debt or using a
combination of both. Our results indicate that the number of firms using both cur-
rency derivatives and foreign currency debt is more than the firms which use only
currency derivatives or only foreign currency debt. Finally, we find that smaller
firms have lesser exchange-rate exposure than larger firms.
The remainder of the article is organized as follows. The second section pro-
vides the review of previous studies. The third section describes data sources and
methodology used in the study. The fourth section discusses the empirical results
and robustness tests. The fifth section provides a summary and the conclusion.
Review of Literature
Theoretically, unexpected exchange-rate movement should have a significant
impact on firm value as it affects both expected cash flows and discount rate. Based
on this theoretical prediction, there are many empirical studies that examine the

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