Foreign exchange rate movements

Introduction

Foreign exchange (FX) rate movements have been one of the major economic and financial factors affecting cash flows and common stocks value. After the collapse of post-war Bretton Woods fixed exchange rates in the 1970's, the relative prices of currencies began to fluctuate. The rapid expansion in international trade and adoption of floating exchange rate regimes by many countries led to increase exchange rate volatility. As economic integration and globalization have been increasing year by year, exchange rate movements have become very important source of risk for financial firms as well as non-financial firms.

Jacque (1996) points out that change in a company's earnings due to unexpected foreign currency exchange rate changes relatively to their domestic currency is considered as foreign exchange rate risks. Changes in exchange rates may affect firms' profitability and value. Exchange rate changes can also impact on the level of competitiveness of the firms which are exposed to exchange rate risk, or affect the value of their net assets denominated in foreign currencies.

Adler and Dumas (1984) show that even firms whose entire operations are domestic may have affects of exchange rates of foreign currencies, if their output and input prices are influenced by currency movements.

Moreover, Eiteman et al. (2006) says that in general, firms are exposed to three types of foreign exchange risk: translation exposure, transaction exposure and economic exposure. In practice, economic exposure is computed as the net sensitivity of some aggregate measure of firm value to currency fluctuations. Economic exposure contains of the direct and indirect effects of currency fluctuations by focusing on the net sensitivity. In practice, there is little general agreement on the use of appropriate choice of ‘‘aggregate'' measure.

Purpose of the report. This project paper aims to assess the economic exposures for five different companies listed in the Consumer Products sector of Bursa Malaysia from the years 2000 to 2008. The project tries to assess economic exposures of (1) Carlsberg Brewery Malaysia, (2) Guinness Anchor Berhad, (3) Mintye Industries, (4) Nestle (Malaysia) and (5) PPB Group.

Economic exposures are assessed by analyzing correlation coefficient between (1) yearly cash flows and yearly exchange rates (2) monthly share prices and monthly exchange rates of six foreign currencies and MYR index rate. In the project Pearson's correlation is used for the analysis.

For the correlation analysis, the balance sheet, profit and loss data from 1999 to 2008 and share prices of the companies from January 15, 2000 to December 15, 2008 were taken from DataStream.

Background Of The Companies.

1. Carlsberg Brewery Malaysia Berhad (Carlsberg Malaysia) is a beverage company which was incorporated in December 1969 and began brewing Carlsberg Green Label beer locally in 1972. The company is foreign owned company and 51% of its shares are owned by Carlsberg Breweries A/S. Carlsberg Malaysia is listed on the Main Board of Bursa Malaysia Securities Berhad (Malaysia Stock Exchange) under the consumer products sector.

2. Guinness Anchor Berhad (GAB) is also a beverage company and it was incorporated on 24th January 1964. 51% of GAB's shares are owned by its parents Guinness Overseas Ltd and Asia Pacific Breweries Limited and 49% of its shares are public. GAB has been listed on the Main Board of Bursa Malaysia Securities Berhad (Malaysia Stock Exchange) under the consumer products sector since 1965.

3. Mintye Industries was established in 1976 in Malacca. It is owned by Eurochain Manufacturer Sdn. Bhd and public shareholders. The company manufactures brake linings, disc brake pads, bonded brake shoes, brake fluid, brake shoe cores, disc pad backing plates and motorcycle chain sprocket. Mintye Industries has been listed on the Main Board of Bursa Malaysia Securities Berhad (Malaysia Stock Exchange) under the consumer products sector since 1994.

4. Nestle Malaysia is a food and beverage company and it was established in 1912 as Anglo-Swiss Condensed Milk Company in Penang. It is foreign-owned and subsidiary of Nestlé S.A. The Company has been publicly listed on the Main Board of Bursa Malaysia Securities Berhad (Malaysia Stock Exchange) under the consumer products sector since 13 December, 1989.

5. PPB Group Berhad was incorporated in Malaysia in 1968 with the initial business of cane cultivation and sugar refining. It was subsequently listed on the Main Board of Bursa Malaysia Securities Berhad (Malaysia Stock Exchange) under the consumer products sector in 1972. PPB has diverse businesses which include the business of flour milling and animal feed milling; livestock farming; food processing; packaging; consumer products distribution; environmental engineering and waste management; contract manufacturing; chemicals manufacturing; engineering services; property development; cinema operations and amusement centre operations.

The report is organized as follows. The results of correlation analysis between yearly cash flows of the companies and yearly exchange rates are discussed in Section 2. Section 3 discusses the results of correlation analysis between monthly share prices of the companies and monthly exchange rates. Finally, Section 4 summarizes the findings of previous sections, particularly about the companies' economic exposure.

Results Of Correlation Analysis Between Yearly Cash Flows Of The Companies And Yearly Exchange Rates

Martin and Mauer suggest that economic exposure, which typically has a longer-term time dimension, encompasses the competitive and indirect effects of exchange rate risk. Many academics such as Hodder (1982), Marston (2001) Pringle (1995), Shapiro (1975) and von Ungern-Sternberg & von Weizsacker (1990) argue that unlike transaction exposure, economic exposure can affect even domestic firms. Economic exposure arises from changes in the sales prices and volumes, and the cost of inputs of the firm and its competitors as a result of exchange rate changes. Miller & Reuer (1998) and Sundaram & Black (1992) argued that geographically positioning production, sales, sourcing, and financing operations is effective for reducing economic exposure.

Company 1. Carlsberg Brewery Malaysia. The results of analysis show that correlation coefficient for cash flows from financing activities of the company is significant. Cash flows from financing activities of the company are negatively correlated with MYR/EUR (-.772), MYR/GBP (-.740), MYR/CHF (-.788) and MYR/SGD (-.777) exchange rates and positively correlated with MYR Index rate (.682). Negative correlation with the currencies mentioned above may be explained that decrease in the financing cash flows are associated with an increase in the exchange rates of MYR/EUR, MYR/GBP, MYR/CHF and MYR/SGD over nine year period of time. However, cash flows from investing activities have been reducing volatile over time as MYR Index rate also has been changing with more volatile pace. We also should add the fact that cash flows from financing activities are not correlated with MYR/USD and MYR/JPY exchange rates. Moreover we can see that cash flows from operating and investment activities are not correlated with any of the seven exchange rate variables.

Correlation results between company cash flow types and exchange rates.

Exchange rates		MYR/ USD	MYR/ EUR	MYR/ JPY	MYR/ GBP	MYR/ CHF	MYR/ SGD	Index rate
Company	Cash flow	MYR/ USD	MYR/ EUR	MYR/ JPY	MYR/ GBP	MYR/ CHF	MYR/ SGD	Index rate
1	Operating	0.004	0.169	0.455	0.157	0.064	0.515	-0.090
	Operating	0.993	0.664	0.219	0.686	0.869	0.156	0.817
	Investment	-0.448	-0.090	-0.258	-0.344	-0.192	0.114	0.487
	Investment	0.226	0.818	0.502	0.365	0.620	0.770	0.183
	Financing	0.224	-.772*	-0.411	-.740*	-.788*	-.777*	.682*
	Financing	0.562	0.015	0.272	0.023	0.012	0.014	0.043
2	Operating	-.738*	.760*	-0.142	0.622	0.651	0.468	-0.274
	Operating	0.023	0.018	0.715	0.074	0.058	0.203	0.476
	Investment	.714*	-.729*	0.032	-0.563	-0.664	-0.381	0.387
	Investment	0.031	0.026	0.934	0.115	0.051	0.312	0.304
	Financing	-0.256	0.457	0.196	0.371	0.426	.675*	-0.298
	Financing	0.506	0.216	0.614	0.326	0.252	0.046	0.437
3	Operating	-0.495	0.561	0.253	0.456	0.407	0.609	-0.202
	Operating	0.175	0.116	0.511	0.218	0.277	0.082	0.603
	Investment	-0.535	0.078	-0.143	0.057	-0.099	0.214	0.188
	Investment	0.137	0.842	0.713	0.883	0.801	0.581	0.628
	Financing	0.042	-0.268	0.206	-0.137	-0.415	-0.063	0.105
	Financing	0.915	0.485	0.595	0.726	0.267	0.872	0.788
4	Operating	-.761*	0.416	-0.422	0.220	0.300	0.072	0.013
	Operating	0.017	0.266	0.257	0.570	0.434	0.855	0.974
	Investment	.948**	-0.364	0.520	-0.037	-0.234	-0.217	-0.236
	Investment	0.000	0.335	0.151	0.925	0.545	0.576	0.541
	Financing	0.423	-0.250	0.284	-0.168	-0.178	0.150	0.036
	Financing	0.257	0.516	0.460	0.667	0.647	0.701	0.926
5	Operating	-.953**	0.574	-0.382	0.357	0.456	0.447	-0.044
	Operating	0.000	0.106	0.310	0.346	0.217	0.228	0.911
	Investment	0.638	-0.301	0.516	-0.350	-0.177	-0.242	-0.143
	Investment	0.065	0.432	0.155	0.355	0.648	0.530	0.714
	Financing	-0.478	0.232	-0.465	0.354	0.128	0.219	0.126
	Financing	0.193	0.549	0.207	0.350	0.743	0.572	0.747

Correlation is significant at the 0.05 level (2-tailed).

Correlation is significant at the 0.01 level (2-tailed).

Company 2. Guinness Anchor Berhad. From the analysis for company 2 it is worth stating that correlation coefficient is significant for cash flows from both operating and investment activities of the company. Operating cash flow of the company is negatively correlated with MYR/USD at the level of -.738 and positively correlated with MYR/EUR exchange rates at .760 level. From these results it can be concluded that as MYR/USD and MYR/EUR exchange rates have been increasing, the company's operating cash flows have been increasing too and the company has been investing more funds as well.

The company's cash flow from its investment activities are also significantly correlated with MYR/USD and MYR/EUR exchange rates. There is positive correlation with MYR/USD exchange rate (.714) and negative correlation with MYR/EUR exchange rate (-.729). Since cash flows from investment activities are negative for the company, it seems that the company may have investment cash inflows denominated in USD and investment cash outflows denominated in EUR.

Besides these, the company's cash flows from its financing activities are positively correlated with MYR/SGD at the level of .675. Since increase in cash flow from financing activities is associated with an increase in the MYR/SGD exchange rate, we can conclude that the company may have been running its financing activities denominated in SGD.

Company 3. Mintye Industries. It would be unfair not to mention that fact that the results for company 3 show no correlation between its cash flows and the seven given exchange rates. From this result we could conclude that the company may have no direct and indirect operations in any of these foreign currencies that could impact its economic exposure. However, the company has international operations with Asian, Europe, Mid East and Oceania countries. We should also mention that among the five companies chosen for the project, Mintye Industries has the lowest amount of all the three types of its cash flows. Perhaps we should also point out other possible fact the company may have implemented very good hedging techniques that it could have avoided impact of exchange rate movements on their operations. On the other hand, that the company's operating, investment and financing activities may have been hedged naturally against economic exposure that there was no impact of exchange rate movements of these seven currencies on its cash flows.

Company 4. Nestle (Malaysia). The company's cash flows from its operating and investment activities have significant correlation with MYR/USD exchange rate. Its operating cash flow is negatively correlated with MYR/USD exchange rate at -.761 level and investment cash flow positively correlated with MYR/USD exchange rate at .948 level. Positive correlation with MYR/USD exchange rate is very significant at the level of 0.0001 sig value. Since MYR has been appreciating against USD and the company's cash flow from operating activities has been rising, the company may have noticeable amount of imported raw materials or payables for services denominated in USD that would reduce cost of goods sold and operating expenses. Besides, the company may have been increasing its productive efficiency, because from the financial statements of the company, we can see that its operating cash flows have been rising rapidly during the last 9 years which is covered by the current project.

The company's cash flows are insignificant with the other exchange rates chosen for the current project.

Company 5. PPB Group's cash flows from its operating activities have very significant correlation with MYR/USD exchange rate. They are negatively correlated at the level of -.953. This correlation may be due to increase in sales, savings from taxes and other expenses. Besides, the group may also have noticeable amount of imported raw materials or payables for services denominated in USD that would reduce cost of goods sold and operating expenses Even though MYR has been appreciating against USD during the last 9 years, despite of negative correlation with MYR/USD exchange rate, the company's operating cash flows also have been rising very rapidly.

That the group's cash flows are not significantly correlated with the other exchange rates could be due to that the group has no activities denominated in these currencies or its activities in these currencies are well hedged against these currencies by its financial officers.

From the analysis done above, it can be concluded that Carlsberg Brewery Malaysia and Guinness Anchor Berhad have higher economic exposure that their cash flows from operating, investment and financing activities are significantly correlated with MYR/USD, MYR/EUR, MYR/GBP, MYR/CHF, MYR/SGD exchange rates and MYR index rate. Cash flows of the companies are mostly exposed by MYR/USD exchange rate and it was found that MYR/JPY exchange rate has no impact on the companies' cash flows.

Results Of Correlation Analysis Between Monthly

Share Prices Of The Companies And Monthly Exchange Rates

The study by Söhnke M. Bartram (2007) found that that several firms are significantly exposed to at least one of the foreign exchange rates, and significant exposures are more frequent at longer horizons. He also argues that the impact of exchange rate risk on stock prices and cash flows is similar and determined by a related set of economic factors.

Dominguez and Tesar (2006) found that exchange rate movements do matter for a significant fraction of firms, though which firms are affected and the direction of exposure depends on the specific exchange rate and varies over time, suggesting that firms dynamically adjust their behavior in response to exchange rate risk. Exposure is correlated with firm size, multinational status, foreign sales, international assets, and competitiveness and trade at the industry level.

Correlation results between company share prices and exchange rates.

Exchange rate	Company 1 share price	Company 2 share price	Company 3 share price	Company 4 share price	Company 5 share price
MYR/USD	.657**	-.587**	.577**	-.739**	-.942**
MYR/USD	.000	.000	.000	.000	.000
MYR/EUR	-.468**	.854**	-.614**	.817**	.715**
MYR/EUR	.000	.000	.000	.000	.000
MYR/JPY	.289**	-.089	.284**	-.111	-.274**
MYR/JPY	.002	.358	.003	.254	.004
MYR/GBP	-.088	.818**	-.367**	.530**	.399**
MYR/GBP	.364	.000	.000	.000	.000
MYR/CHF	-.455**	.776**	-.597**	.771**	.606**
MYR/CHF	.000	.000	.000	.000	.000
MYR/SGD	-.431**	.799**	-.533**	.808**	.727**
MYR/SGD	.000	.000	.000	.000	.000
Index rate	-.148	-.523**	.075	-.302**	-.072
Index rate	.126	.000	.440	.002	.461

Correlation is significant at the 0.05 level (2-tailed).

Correlation is significant at the 0.01 level (2-tailed).

Company 1. Carlsberg Brewery Malaysia. The company's share prices are significantly correlated with 5 exchange rates and have insignificant correlation coefficient with MYR/GBP exchange rate and MYR index rate as well. The share prices are highly positively correlated with MYR/USD at the .657 level and with MYR/JPY at the .289 level. It is very noticeable to see that this company's financing cash flows were insignificantly correlated with these 2 exchange rates.

The company's share prices are negatively correlated with MYR/EUR exchange rate at the -.468 level, MYR/CHF at the -.455 level and MYR/SGD at the -.432 level. It means that depreciation of MYR against EUR, CHF and SGD could reduce the company's value influencing its cash flows. We can see that the company's net cash flow has been reducing during the last 9 years. Besides from the result of analysis from the previous section, we can see that the company's financing cash flows are also significantly correlated with these exchange rates, the company's share prices could be affected negatively as well. Since the company's financing cash flows also have been reducing during the last 9 years we can see positive significant correlation between the company's financing cash flow and share prices that at the same time its share prices also have been declining inconstantly.

Company 2. Guinness Anchor Berhad. The company's share prices are significantly correlated with 5 exchange rates and MYR index rate and have insignificant correlation coefficient with MYR/JPY exchange rate. There is positive correlation between the company's share prices and MYR/EUR (.854), MYR/GBP (.818), MYR/CHF (.776) and MYR/SGD (.799) exchange rates. The share prices are negatively correlated with MYR/USD exchange rate (-.587) and MYR index rate (-.523). Perhaps the company might have some cash inflows denominated in EUR, GBP, CHF and SGD and cash outflows denominated in USD so that the depreciation of MYR against EUR, GBP, CHF and SGD could have been increasing the cash inflows in MYR terms. From the financial statements, we can see that its net cash flows have been increasing during the last 9 years, which could raise the value of the company. Therefore, may be the company's share prices have been increasing.

Company 3. Mintye Industries. The company's share prices are significantly correlated with 6 exchange rates. However there is insignificant correlation coefficient between the share prices and MYR index rate. The share prices are positively correlated with MYR/USD at the .577 level and MYR/JPY exchange rates at the .284 level, while there is negative significant correlation between the share prices and MYR/EUR (-.614), MYR/GBP (-.367), MYR/CHF (-.597) and MYR/SGD (-.533) exchange rates.

According to the information provided on the company's website, 30% of its sales are in Asian countries including Japan. Therefore, increase in MYR/JPY exchange rate (depreciation of MYR against JPY) might have positive impact on its cash flows that could result its share prices to be significantly positively correlated with MYR/JPY exchange rate. Also 5% of sales are in Europe including United Kingdom. It shows us that decrease in MYR/GBP exchange rate could reduce the company's cash flows in MYR terms and therefore the share prices could decline.

Company 4. Nestle Malaysia's share prices have significant correlation with all the exchange rates except for the MYR/JPY exchange rate. They have positively significant correlation with MYR/EUR (.817), MYR/GBP (.530), MYR/CHF (.771) and MYR/SGD (.808) exchange rates. Share prices of the company are negatively correlated with MYR/USD exchange rate at the .739 level and with MYR index rate at the .302 level.

We can see that share prices raised to MYR 27.00 per share in December 2008 from MYR 17.30 per share in January 2000. As Nestle Malaysia is a subsidiary of Multinational company Nestle A.S. it may have many operations with its parent and other subsidiaries abroad. Therefore it has more cash flows denominated in other currencies such as EUR, GBP, CHF and SGD. Any change in the exchange rates of these currencies may effect the company's cash flows and finally its value. That's why it has positive correlation with these currencies. And there is negative correlation between its operating cash flow and share prices and MYR/USD exchange rate, which says that depreciation in USD value against MYR would raise the company's share prices.

Company 5. PPB Group. This company's share prices have significant correlation with 6 exchange rates and insignificant correlation with MYR index rate. The share prices are negatively correlated with MYR/USD at the -.942 level and MYR/JPY exchange rates at the -.274 level, while there is positive significant correlation between the share prices and MYR/EUR (.715), MYR/GBP (.799), MYR/CHF (.606) and MYR/SGD (.727) exchange rates.

PPB Group's operations spread over Malaysia, China, Vietnam, Myanmar, Thailand, Singapore and Indonesia. Therefore, the group could have cash inflows denominated in foreign currencies such as SGD, USD, EUR, GBP and CHF as well. Changes in the exchange rates of these currencies impact the group's cash flows and its value. From these facts we can conclude that cash flows from these operations denominated in foreign currencies are the main reason for significant correlation between these currencies and the share prices of the group.

In this analysis, it is found that all of the companies have almost equal economic exposures. Mostly, MYR/USD, MYR/EUR, MYR/CHF, MYR/SGD exchange rates influence more economic exposures of these companies.

Summary And Conclusion

This project paper tried to assess the economic exposures for five different companies listed in the Consumer Products sector of Bursa Malaysia from the years 2000 to 2008 using correlation coefficient between (1) yearly cash flows and yearly exchange rates (2) monthly share prices and monthly exchange rates of six foreign currencies and MYR index rate.

From results of correlation analysis between yearly cash flows of the companies and yearly exchange rates, it can be concluded that Carlsberg Brewery Malaysia and Guinness Anchor Berhad have higher economic exposure that their cash flows from operating, investment and financing activities are significantly correlated with MYR/USD, MYR/EUR, MYR/GBP, MYR/CHF, MYR/SGD exchange rates and MYR index rate.

Cash flows from financing activities of Carlsberg Brewery Malaysia are negatively correlated with MYR/EUR, MYR/GBP, MYR/CHF and MYR/SGD exchange rates and positively correlated with MYR Index rate. At the same time, other types of cash flows of the company are not correlated with exchange rates.

Guinness Anchor Berhad's operating cash flow is negatively correlated with MYR/USD and positively correlated with MYR/EUR rate, while its cash flow from investment activities is positively correlated with MYR/USD exchange rate and negatively correlated with MYR/EUR exchange rate.

Three companies' operating cash flows and two companies' investment cash flows are mostly exposed by MYR/USD exchange rate and it was found that MYR/JPY exchange rate has no impact on the companies' cash flows.

However, the results of correlation analysis between monthly share prices of the companies and monthly exchange rates show that all of the companies have almost equal economic exposures. Mostly, MYR/USD, MYR/EUR, MYR/CHF, MYR/SGD exchange rates influence more economic exposures of these companies.

As a summary of these results Carlsberg Brewery Malaysia and Guinness Anchor Berhad are considered to have higher economic exposure among these five different companies from the Consumer products sector of Bursa Malaysia. Besides, MYR/USD exchange rate is found to have more influence on the companies' cash flows and share prices.

From these arguments we can conclude that share prices of the companies are more sensitive to exchange rate movements. Nevertheless, some of the companies have operations with foreign partners as a result of which they have cash flows denominated in foreign currencies. Therefore, exchange rates influence their cash flows which will effect the company's value.

Martin and Mauer (2003) pointed out that cash flow effects are greater for long-term lags than for short-term lags in exchange rate movements. This result may occur because transaction exposure is easier to assess and hedge, whereas economic exposure is more difficult to recognize and hedge. While Bartram (2007) suggests that several firms are significantly exposed to at least one of the foreign exchange rates such as CAD, JPY and EUR, and significant exposures are more frequent at longer horizons. The percentage of firms for which stock price and earnings exposures are significantly different is relatively low, though it increases with time horizon. Overall, he is convinced that the impact of exchange rate risk on stock prices and cash flows is similar and determined by a related set of economic factors.

Factors such as firm size, multinational status, foreign sales, international assets, and competitiveness and trade at the industry level may influence economic exposure of the companies.

Refenrences

Martin. A. D, L Mauer J. (2003). Transaction Versus Economic Exposure: Which Has Greater Cash Flow Consequences? International Review Of Economics And Finance 12, 437-449.

Bartram,S. M, (2007). Corporate Cash Flow And Stock Price Exposures To Foreign Exchange Rate Risk. Journal Of Corporate Finance 13, 981-994.

Bartram, S. M, Dufey G, Frenkel. M. R. (2005). A Primer On The Exposure Of Non-Financial Corporations To Foreign Exchange Rate Risk. Journal Of International Financial Management 15, 394-413.

Essay removal request