Econometrics Project: Assessing Exchange Rate Exposure of Listed Firms

This econometrics project examines the exchange rate exposure of UK multinationals, with a specific focus on Unilever Plc. The report introduces the topic by highlighting the impact of foreign exchange rate fluctuations on businesses, particularly their cash flows and profitability. It defines exchange rate exposure and discusses the associated risks, distinguishing between risk and exposure in the context of currency fluctuations. The project explores various determinants of exchange rate exposure and how multinationals manage these exposures. The main body of the project investigates the measurement of exposure to currency fluctuations, emphasizing the use of financial instruments to manage related risks. The project addresses the impact of exchange rate fluctuations on businesses involved in international trade and those with global investments. The project aims to identify, analyze, and measure the exchange rate exposures of UK multinationals, providing insights into the sensitivity of firm value due to changes in exchange rates, and using regression analysis to quantify this relationship. The project adheres to the guidelines of an econometrics project, including a clear research question, data analysis, and interpretation of results. The project includes references to relevant literature and aims to be accessible to a non-expert audience with a grounding in econometrics.

ECONOMETRICS
PROJECT

INTRODUCTION
With the expansion of businesses and their operations at global level, the risk associated
with the fluctuations in foreign exchange rate has gain a high level of attention as it acts as a
source of uncertainty to business’s cash flows and accordingly profitability. It would be true to
believe that these fluctuations in exchange rate has a great effect of firm’s value. Exchange rates
are considered as the uncertainty source for a multinational corporation. The purpose of this
report is to identify and analyze exchange rate exposures of UK multinationals and more
specifically Unilever Plc, a UK based consumer goods multinational corporation. Exposures are
created to indicate the sensitiveness of the firm’s value due to fluctuations in exchange rate
which can be measured through regression coefficient of the changing firm’s value as a result of
change in exchange rate. Exchange rate exposure can be defined as the uncertainty caused due to
unintuitive fluctuations between the currency’s exchange rate. So, in this report various
determinants of exchange rate exposure, how multinationals create their exposure for different
currencies along with the measurement of these exposures will be discussed.
MAIN BODY
Risk vs Exposure
It cannot be said that currencies are risky proposals as it is normal that currency’s get devalued
and if this is certain with reference to time and magnitude, then there would be no risk. When
there is a movement in the exchange rate, then this gave rise to foreign exchange risk and foreign
exchange exposure. These terms of risk and exposure in the context of foreign exchange are
usually used interchangeably, but these are different concepts. It is believed that a weak currency
is less risky than a strong one. Also, a currency which is strong is not prone to any risk as it is
used for denominating firm’s or individual’s debt. Risk and uncertainty arises due to unexpected
changes in the exchange rates. The risk of currency fluctuations is determined through statistical
measures which helps in identifying the probability of difference in the actual and anticipated
purchasing power of the domestic or foreign currency at some future date. Exposure on the other
Exchange rate exposure or currency risk exposure
In order to fulfill the very purpose of financial analysis, there is a need to measure the exposure
to risk of currency fluctuations. When these risks associated with currency expressed in
quantifiable terms, then it is known as exposure. So the exchange rate exposure gave rise to the
use of instruments such as forwards, futures and money market instruments with the view to
manage the risks associated with it. It can be said that the exposure to foreign exchange may
results in negative impacts to firm’s performance due to the rise of financial risk associated with
the unanticipated changes in the rate of exchange between the two currencies. It always affects
those businesses who are indulged in exporting and importing their goods and services to and
from other countries respectively. Also, those companies who holds investments across the globe
are always exposed to the risk or currency exchange rate fluctuations and the same can leads to
severe consequences in terms of financial stability for a concern if it would not be managed
accordingly.