Foreign Exchange Rate Sensitivity and Stock Price
FOREIGN EXCHANGE RATE SENSITIVITY AND STOCK PRICE : ESTIMATING ECONOMIC EXPOSURE OF TURKISH COMPANIES
INTRODUCTION
Variability in exchange rate is a major source of macroeconomic uncertainity affecting firms. After the 1970 's, the rapid expansion in international trade and adoption of floating exchange rate regimes by many countries led to increase exchange rate volatility. The firm 's exposure to exchange rate risk increased.
In the literature three types of exposure under floating exchange rate regimes are identified; economic, translation and transaction. Translation and transaction exposures are accounting based and defined in terms of the book values of assets and liabilities denominated in foreign currency. Economic exposure is the sensitivity of company value to exchange rate movements. At the corporate level, changes in exchange rates affect the firm value, because future cash flows of the firm will change with exchange rate fluctuations. In other words, exchange rate changes have important implications for financial decision-making and for firm profitability.
Adler and Dumas (1984) show that even firms whose entire operations are domestic may be affected by exchange rates, if their input and output prices are influenced by currency movements.
It is widely believed that changing exchange rates affect the competitiveness of firms engaged in international competition. A falling home currency promotes the competitiveness of firms in home country by allowing them to undercut prices charged for goods manufactured abroad (Luehrman, 1991). Many simple partial equilibrium models (e.g. Shapiro) predict an increase in the value of the home country firm in response to a real drop in the value of the home currency. Economic theory suggests that under a floating exchange rate regime, exchange rate appreciation reduces the competitiveness of export markets; it has a negative effect on the domestic stock market. Conversely, if the country is import denominated,
INTRODUCTION
Variability in exchange rate is a major source of macroeconomic uncertainity affecting firms. After the 1970 's, the rapid expansion in international trade and adoption of floating exchange rate regimes by many countries led to increase exchange rate volatility. The firm 's exposure to exchange rate risk increased.
In the literature three types of exposure under floating exchange rate regimes are identified; economic, translation and transaction. Translation and transaction exposures are accounting based and defined in terms of the book values of assets and liabilities denominated in foreign currency. Economic exposure is the sensitivity of company value to exchange rate movements. At the corporate level, changes in exchange rates affect the firm value, because future cash flows of the firm will change with exchange rate fluctuations. In other words, exchange rate changes have important implications for financial decision-making and for firm profitability.
Adler and Dumas (1984) show that even firms whose entire operations are domestic may be affected by exchange rates, if their input and output prices are influenced by currency movements.
It is widely believed that changing exchange rates affect the competitiveness of firms engaged in international competition. A falling home currency promotes the competitiveness of firms in home country by allowing them to undercut prices charged for goods manufactured abroad (Luehrman, 1991). Many simple partial equilibrium models (e.g. Shapiro) predict an increase in the value of the home country firm in response to a real drop in the value of the home currency. Economic theory suggests that under a floating exchange rate regime, exchange rate appreciation reduces the competitiveness of export markets; it has a negative effect on the domestic stock market. Conversely, if the country is import denominated,