Skip to main content
SpringerLink
Log in

Exchange Rate Risk Management using Currency Derivatives: The Case of Exposures to Japanese Yen

  • Original Research
  • Published:
Asia-Pacific Financial Markets Aims and scope Submit manuscript

Abstract

This paper focuses on managing exchange rate risk associated with a secondary, non-USD exchange rate of Japanese yen (JPY). Employing Korean firm data, our preliminary analysis reveals that Korean firms are exposed differently to changes in the KRW/JPY rate than to changes in the KRW/USD rate. Our results show that firms exhibiting significant shifts in exposure from pre- to post-global financial crisis have distinctively different firm attributes including more currency derivatives use and lower firm values, compared to firms exhibiting little such shifts. A further analysis reveals that the lower values of high exposure firms are attributable mainly to the financial risk from foreign currency borrowing, but not to the operating risk resulting from exporting activities. Hence, the currency derivative use by Korean firms hardly helps them mitigate the value loss from heightened capital costs of foreign borrowing following the crisis.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1

Source Trading Economics (https://tradingeconomics.com/)

Fig. 2

Source Trading Economics (https://tradingeconomics.com/)

Fig. 3

Source Trading Economics (https://tradingeconomics.com/)

Fig. 4

Source Trading Economics (https://tradingeconomics.com/)

Fig. 5

Source The Bank of Korea and Company Annual Reports

Similar content being viewed by others

Notes

  1. This domestic-currency or yen invoicing helps Japanese firms in reducing their exchange rate exposure. Ito et al. (2016) show that among others, the invoice currency choice affects Japanese firms’ exchange rate exposure that while the higher the USD invoicing share, the greater the exchange rate exposure, yen invoicing reduces their exposure.

  2. Unlikely trades with the U.S. and China, Korea has recorded a trade deficit with Japan in the range of $10.1 billion to $36.1 billion per year over the last two decades. For 2020 year alone, Korea’s export to Japan was $25.1 billion (3rd largest, representing 4.9% of total export), and Korea’s import from Japan amounted to over $46.0 billion (3rd largest, representing 9.8% of total import), resulting in a trade deficit of $20.9 billion with Japan.

  3. See, e.g., Allayannis and Ofek (2001) and Brown (2001) for U.S. firms; Bae et al. (2018) for Korean firms; Bradley and Moles (2002) for U.K. firms; Yip and Nguyen (2012) for Australian firms; Yong et al. (2009) for Asia–Pacific banks.

  4. Unlike other variables, a firm’s’ import ratio is not publicly available nor measurable and hence proxied by the firm’s imported input shares relative to sector sales (Bae & Kwon, 2013).

  5. https://www.kisvalue.com/web/index.jsp

  6. Since listed Korean firms adopted the International Financial Reporting Standards in 2011, the reporting of derivatives contracts has been done voluntarily in varying forms, which prevents from collecting complete derivatives contract information.

  7. To construct a sample of firms highly exposed to KRW/USD rate, we follow the same procedures as described in Sect. 2.1 for our sample of high exposure firms to KRW/JPY rate.

  8. Borrowing in foreign currency by Korean firms rose from the pre-crisis level of 6.1% to 6.4% during the crisis (Bae, et al., 2016). The unprecedented level of foreign currency debt not only caused a severe liquidity imbalance due to substantially lower foreign currency denominated assets (5.3%) but also resulted in increased capital costs due to the rapid depreciation of KRW against other currencies during the crisi.

  9. As noted in Clark and Judge (2009), these results are mainly due to the rigid and long-term attribute of derivatives instruments for hedging risk from foreign currency borrowing during their contractual periods.

References

  • Allayannis, G., Brown, G. W., & Klapper, L. F. (2003). Capital structure and financial risk: Evidence from foreign debt use in East Asia. Journal of Finance, 58, 2667–2709.

    Article  Google Scholar 

  • Allayannis, G., & Ofek, E. (2001). Exchange rate exposure, hedging, and the use of foreign currency derivatives. Journal of International Money and Finance, 20, 273–296.

    Article  Google Scholar 

  • Asif, R., & Frömmel, M. (2022). Exchange rate exposure for exporting and domestic firms in central and eastern Europe. Emerging Markets Review, 51(2022), 100863.

    Article  Google Scholar 

  • Bae, S. C., Kim, H. S., & Kwon, T. H. (2016). Foreign currency debt financing, firm value, and risk: Evidence from Korea surrounding global financial crisis. Asia-Pacific Journal of Financial Studies, 45, 124–152.

    Article  Google Scholar 

  • Bae, S. C., Kim, H. S., & Kwon, T. H. (2018). Currency derivatives for hedging: New evidence on determinants, firm risk, and performance. Journal of Futures Markets, 38, 446–467.

    Article  Google Scholar 

  • Bae, S. C., & Kwon, T. H. (2013). Asymmetric foreign exchange exposure, option trade, and foreign currency denominated debt: Evidence from Korea. Asia-Pacific Journal of Financial Studies, 42, 314–339.

    Article  Google Scholar 

  • Bae, S. C., & Kwon, T. H. (2021). Hedging operating and financing risk with financial derivatives during the global financial crisis. Journal of Futures Markets, 41, 384–405.

    Article  Google Scholar 

  • Bartram, S., Brown, G. W., & Conrad, J. (2011). The effects of derivatives on firm risk and value. Journal of Financial and Quantitative Analysis, 46, 967–999.

    Article  Google Scholar 

  • Bartram, S., Brown, G. W., & Fehle, F. R. (2009). International evidence on financial derivatives usage. Financial Management, 38, 185–206.

    Article  Google Scholar 

  • Bartram, S., Brown, G. W., & Minton, B. (2010). Resolving the exposure puzzle: The many facets of exchange rate exposure. Journal of Financial Economics, 95, 148–173.

    Article  Google Scholar 

  • Bodnar, G. M., & Gentry, W. M. (1993). Exchange rate exposure and industry characteristics: Evidence from Canada Japan, and the USA. Journal of International Money and Finance, 12, 29–45.

    Article  Google Scholar 

  • Bodnar, G. M., & Wong, M. H. F. (2003). Estimating exchange rate exposures: Issues in model structure. Financial Management, 32, 35–67.

    Article  Google Scholar 

  • Bradley, K., & Moles, P. (2002). Managing strategic exchange rate exposures: Evidence from UK firms. Managerial Finance, 28, 28–42.

    Article  Google Scholar 

  • Brown, G. W. (2001). Managing foreign exchange risk with derivatives. Journal of Financial Economics, 60, 401–448.

    Article  Google Scholar 

  • Caves, R., Porter, M., Spence, A., & Scott, J. (1980). Competition in the open economy: A model applied to Canada. Harvard University Press.

    Google Scholar 

  • Chang, Y. C., & Lin, H. J. (2005). The use of foreign currency derivatives and foreign-denominated debts to reduce exposure to exchange rate fluctuations. International Journal of Management, 22, 598–604.

    Google Scholar 

  • Clark, E., & Judge, A. (2009). Foreign currency derivatives versus foreign currency debt and the hedging premium. European Financial Management, 15, 606–642.

    Article  Google Scholar 

  • Clark, E., & Mefteh, S. (2010). Foreign currency derivatives use, firm value and the effect of the exposure profile: Evidence from France. International Journal of Business, 15, 183–196.

    Google Scholar 

  • Data Citation: Financial Supervisory Service; Data Analysis, Retrieval and Transfer System; http://dart.fss.or.kr/.

  • Data Citation: Korea Listed Companies Association; Total Solution (TS) 2000; http://www.kocoinfo.com.

  • Data Citation: Trading Economics; https://tradingeconomics.com/.

  • Dominguez, K. M. E., & Tesar, L. L. (2006). Exchange rate exposure. Journal of International Economics, 68, 188–218.

    Article  Google Scholar 

  • Dumas, B., & Solnik, B. (1995). The world price of foreign exchange risk. Journal of Finance, 50, 445–479.

    Article  Google Scholar 

  • Geczy, C., Minton, B. A., & Schrand, C. (1997). Why firms use currency derivatives. Journal of Finance, 52, 1323–1354.

    Article  Google Scholar 

  • Graham, J. R., & Rogers, D. (2002). Do firms hedge in response to tax incentive? Journal of Finance, 57, 815–840.

    Article  Google Scholar 

  • Guay, W., & Kothari, S. (2003). How much do hedge with derivatives? Journal of Financial Economics, 70, 423–461.

    Article  Google Scholar 

  • Hagelin, N. (2010). Why firms hedge with currency derivatives: An examination of transaction and translation exposure. Applied Financial Economics, 20, 55–69.

    Google Scholar 

  • He, J., & Ng, L. (1998). The foreign exchange exposure of Japanese multinational corporations. Journal of Finance, 53, 733–753.

    Article  Google Scholar 

  • Hentschel, L., & Kothari, S. P. (2001). Are corporations reducing or taking risks with derivatives? Journal of Financial and Quantitative Analysis, 36, 93–118.

    Article  Google Scholar 

  • Ito, T., Koibuchi, S., Sato, K., & Shimizu, J. (2016). Exchange rate exposure and risk management: The case of exporting firms. Journal of the Japanese and International Economies, 41, 17–29.

    Article  Google Scholar 

  • Jin, Y., & Jorion, P. (2006). Firm value and hedging: Evidence from US oil and gas producers. Journal of Finance, 61, 893–919.

    Article  Google Scholar 

  • Jorion, P. (1990). The exchange-rate exposure of US multinationals. Journal of Business, 63, 331–345.

    Article  Google Scholar 

  • Jorion, P. (1991). The pricing of exchange rate risk in the stock market. Journal of Financial and Qualitative Analysis, 26, 353–376.

    Article  Google Scholar 

  • Korea International Trade Association, http://www.kita.org/kStat/byCount_AllCount.do.

  • Kwon, T. H., Bae, S. C., & Chung, J. M. (2005). Do foreign investors price foreign exchange risk differently? Journal of Financial Research, 28, 555–573.

    Article  Google Scholar 

  • Muller, A., & Verschoor, W. F. C. (2006). Foreign exchange risk exposure: Survey and suggestions. Journal of Multinational Financial Management, 16, 385–410.

    Article  Google Scholar 

  • Parlapiano, F., Alexeev, V., & Dungey, M. (2017). Exchange rate risk exposure and the value of European firms. European Journal of Finance, 23, 111–129.

    Article  Google Scholar 

  • Salifu, Z., Osei, K. A., & Adjasi, C. K. D. (2007). Foreign exchange risk exposure of listed companies in Ghana. Journal of Risk Finance, 8, 380–393.

    Article  Google Scholar 

  • Taylor, M. P., Wang, Z., & Xu, Q. (2021). Real effect of exchange rate risk on corporate investment: International evidence. Journal of International Money and Finance, 117, 102432.

    Article  Google Scholar 

  • UN Comtrade (United Nations International Trade Statistics Database), https://comtrade.un.org/.

  • Wei, K. D., & Starks, L. T. (2013). Foreign exchange exposure elasticity and financial distress. Financial Management, 42, 709–735.

    Article  Google Scholar 

  • White, H. (1980). A heteroskedasticity-consistent covariance matrix estimator and direct test for heteroskedasticity. Econometrica, 48, 817–838.

    Article  Google Scholar 

  • Yip, W. H., & Nguyen, H. (2012). Exchange rate exposure and the use of foreign currency derivatives in the Australian resources sector. Journal of Multinational Financial Management, 22, 151–167.

    Article  Google Scholar 

  • Yong, H. H. A., Faff, R., & Chalmers, K. (2009). Derivative activities and Asia-Pacific banks’ interest rate and exchange rate exposures. Journal of International Financial Markets, Institutions and Money, 19, 16–32.

    Article  Google Scholar 

Download references

Acknowledgements

The authors wish to acknowledge many valuable comments from Mingsheng Li and two anonymous reviewers of the Journal on the earlier version of the paper. The work was supported by the Ministry of the Republic of Korea and the National Research Foundation of Korea (NRF-2021S1A5B8096365). The usual disclaimer applies.

Author information

Authors and Affiliations

  1. Department of Finance, Schmidthorst College of Business, Bowling Green State University, Bowling Green, OH, 43403, USA

    Sung C. Bae

  2. School of Business, Chungnam National University, Daejon, Korea

    Taek Ho Kwon

Authors
  1. Sung C. Bae
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Taek Ho Kwon
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Sung C. Bae.

Additional information

Publisher's Note

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Rights and permissions

Springer Nature or its licensor (e.g. a society or other partner) holds exclusive rights to this article under a publishing agreement with the author(s) or other rightsholder(s); author self-archiving of the accepted manuscript version of this article is solely governed by the terms of such publishing agreement and applicable law.

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Bae, S.C., Kwon, T.H. Exchange Rate Risk Management using Currency Derivatives: The Case of Exposures to Japanese Yen. Asia-Pac Financ Markets 30, 621–647 (2023). https://doi.org/10.1007/s10690-022-09391-7

Download citation

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10690-022-09391-7

Keywords

JEL Classification

Search

Navigation