FOREIGN EXCHANGE EXPORUSE ON MNCS FINANCING,

INVESTING AND RETURNS

GROUP MEMBER:
TEE CHEE YOONG

(A143348)

WONG SONG WEN

(A143224)

NURUL JANNAH BINTI ZAINAL

(A143096)

INSTRUCTOR:
DR. NOOR AZRYANI BINTI AUZAIRY

EPPM 4433: INTERNATIONAL FINANCE

SEMESTER 1

SESSION 2014/2015

SCHOOL OF MANAGEMENT
FACULTY OF ECONOMICS & MANAGEMENT

CHAPTER 1
INTRODUCTION

1.0 PROBLEM STATEMENT

The main purpose of this research paper is to determine on how the foreign exchange
exposure operating in Multinational Company (MNC) based on its financing,
investing and return.

1.2 PAPER OBJECTIVES

To study on how the exchange rate fluctuations be able to affect the companies.

1.3 PAPER SCOPE AND CONTRIBUTION

In order to know if the exchange rate fluctuations be able to affect the companies, we
decided to choose the multinational companies that operated in the same industries
which is automotive industry. The reason why we choose the companies in the same
industry is to get the significant findings between the companies. Besides that, we
chose automotive industry because there is no empirical study found in this industry
that related to foreign exchange.

CHAPTER 2
LITERATURE REVIEW

Foreign Direct Investment (FDI) is an international flow of capital that provides a

parent company or multinational firms with control over foreign affiliates. By 2005,
inflows of foreign direct investment around the world rose to $916 billion, with more
than half of these flows received by businesses within developing countries. The
behavior of exchange rates is one of the many influences on Foreign Direct
Investment. Exchange rates can affect the total amount of foreign direct investment to
take place and the division of this amount spending through the others countries.
Some specialist on FDI implications of exchange rate changes put out of their
judicial consideration on the empirical relevance of the interest-parity type of caveat.
On the contrary, it is argued that there are inadequate capital market considerations,
leading the rate of return on investment projects to depend on the structure of capital
markets across the others countries. For example, Froot and Stein (1991) argue that
capital markets are not perfect and lenders do not have adequate information about the
results of their overseas investments. In this situation, multinational companies, which
lend or raise capital internationally to pay for their overseas investment projects need
to provide their creditors some extra compensation to cover the high costs of
monitoring their investments overseas. Multinationals would more likely to finance
the investment projects out of internal capital if this were an alternative, since internal
capital is exchanging in the parent companys profitability.
Blonigen (1997) makes a firm-specific asset argument to support a role for
exchange rates movements in effecting foreign exchange investment. Suppose that
foreign and local firms have same opportunity to purchase firm-specific assets in the
local market, but different opportunities to yields returns on these assets in foreign
markets. In this scenario, currency movements may relatively influence the valuations
of different assets. While domestic and foreign firms pay in the same currency, the
firm-specific assets may produce profit in different currencies. The exchange rate
movements are influencing the acquisitions of assets by foreign firms. For instances,

when a local firm and foreign firm bid for a foreign target form with firm-specific
assets, depreciates of the foreign currency can increase demand of local acquisitions
of target firms. Data on Japanese acquisitions in the United States have been proven
the hypothesis that dollar depreciations make Japanese acquisitions more likely in
United States industries with firm-specific assets.
In addition to support the effects of levels of exchange rates, volatility of
exchange rates also influences on foreign direct investment activity. Theoretical
arguments for volatility effects are classified into two types which are production
flexibility arguments and risk aversion arguments. For production flexibility
arguments, consider the implications of having a production structure whereby
producers need to perform investment capital to local and foreign capacity before they
know the accurate production costs and accurate amounts of products need to be
ordered from them in the future. The producer commits to actual levels of
employment and the location of production after the exchange rates and demand
conditions are known. Aizenman (1992) demonstrated, to understand the degree to
which exchange rate variability effecting foreign investment based on the sunk costs
in capacity, on the competitive structure of the industry, and on the profit function in
prices. By the production flexibility arguments, after exchanges rates are determined,
more volatility is associated with more foreign direct investmentex ante, and more
potential for over capacity and production shifting ex post.
An alternative approach linking exchange-rate variability and investment
based on risk aversion arguments. The logic is that investors require payment for risks
that exchange rate movements introduce additional risk into the returns on investment.
Cushman (1985, 1988), the higher the variability of exchange rates, the lowers the
certainty expected exchange rate level. Since certainty equivalent levels are used in
the predicted profit functions of firms that make investment decisions today in order
to realize profits in future periods. If exchange rates are highly instable, the expected
values of investment projects are decreased, and foreign direct investment will
decreased accordingly. These two arguments, production flexibility versus risk
aversion, provide different areas of predictions of exchange rate volatility
implications on foreign direct investment.

Although theoretical arguments give the conclusion that the share of total
investment overseas may rise as exchange rate volatility increases, this does not
means that exchange rate volatility depresses domestic investment activity. In order to
conclude that domestic aggregate investment decreases, one must show that the rise in
domestic outflows is not offset by an increase in foreign inflows. In the United States
economy, exchange rate volatility not had large contractionary effect on total
investment (Goldberg 1993).
A multinational firm is defined as a firm that has at least one majority owned
foreign subsidiary. MNC companies will expose in the foreign exchange market on
their transaction. For the relationship between MNC companies and exchange rate,
Ajayi & Mougoue (1996) indicated that exchange rate fluctuations affected stock
prices negative significantly because there have a positive relationship between stock
prices and US dollars existed (depreciation of US dollars leading to decreased stock
prices in America). Ajayi & Mougoue (1996) used error correction models (ECM),
found evidence that exchange rates changes exerted significant dynamic influence on
stock returns for eight industrialized countries.
According to Dr. Yaw-Yih Wang, exchange rate fluctuations were positively
correlated to stock returns in the food industries whose stock returns were influenced
by exchange rate changes, which mean stock returns increased as the depreciate of
domestic currency against foreign currency. For the industries whose stock returns
were affected by exchange rate fluctuations, a positive correlation existed between
exchange rate fluctuations and stock returns (Dr. Yaw-Yih Wang).
According to Jorions (1990), the sample firms that shows a significant
contemporary exchange rate exposure only found in a small percentage which is only
5% out of 287 multinational companies that has been empirically examined to study
the relationship between the exchange rate changes and its stock returns at United
States. It is vital for suppliers of investment capital to know and have a good
understanding about the sensitivity of firm standards to exchange rate. To recognize
the response of individual stock returns to exchange rate changes, they should think
about the economic features of a firm that would connect operating profitability and
expected future cash flows to unexpected exchange rate changes. Kogut (1983) said

that, direct investment in international markets can help firms to decrease their
exposure to uncertain environmental conditions.
According to Ahmed (2007) research, the finding of the research shows that a
higher proportion of firms gain from an appreciation of the pound tend to allow the
high proportion of positive exposure coefficients among firms with significant
exchange rate exposure. Next, the results also specify evidence that firms foreign
processes and hedging variables will influence their sensitivity to exchange rate
exposure.
According to Huang (2003), market share mechanisms are getting worse by
exchange rate expectation in open economies. The degree of exchange rate passthrough getting higher in the short-run compared to the long run. Besides that, there
are many cases of pair-wise were found. Thus, the competition in the international
market can be enhanced by improving our understanding of the outcomes of exchange
rate actions on foreign exporters pricing. This research shows us the impact of
expectations on the market instrument.
By applying hedging plans along with the decentralization to subsidiaries,
foreign corporations that have been exposed to exchange risks in rising markets will
achieve its flexibility when they decide to choose a cross-functional approach for the
evaluation. By this approach, it can help out the corporations in structuring the
situations, assessing the probable impact of exchange rate variations, scheming preemptive measures and setting alternative plans to lessen potential impacts (Cardoza
and Forns, 2009).

SUMMARY TABLE OF LITERATURE REVIEW

N
o
1

Aut

Objectives

hor
(year)
Aiz

To

analyze

enman

implications

(1992)

exchange
flexibility

Meth
odology

Findings

Correl

Nominal

the
of

on

in

ation,

flexible exchange rate regime

rate

Macro

have adverse implications on

the

model

investment behaviour and that

patterns of domestic

attempts to encourage FDI may

and

benefit by adapting a fixed

foreign

direct

investment.
2

shocks

Blo

exchange rate.

This paper argues

nigen

that

(1997)

exchange

rate

ANO

Data

on

Japanese

VA,

acquisitions in the United States

movements may affect

Coefficient

have been proven the hypothesis

acquisition

that dollar depreciations make

FDI

because

acquisitions

involve

firm-specific

assets

which

generate

can

returns

in

One-

sample

Japanese

acquisitions

more

test,

likely in United States industries

Correlatio

with firm-specific assets.

n,

currencies other than

that used for purchase.
3

Cus

To examine direct

Regre

Exchange

rates

and

hman

investment on foreign

ssion

inflation rates are uncertain,

(1985,1

and

model,

random fluctuations in the real

988)

production.

correlation

exchange rate can lead to a

domestic

variety of risk and expectational

effects on direct investment.
4

Fro
ot

and

To examine
connection

Stein

exchange

(1991)

foreign

the

between
rates

and
direct

investment that arises

Regre

Exchange rate volatility can

ssion,

contribute

correlation

internationalization
production

to
activity

the

of

without

depressing economic activity in

when

globally

the home market. The actual

capital

movements of exchange rates

markets are subject to

can also influence FDI through

informational

imperfect

imperfections.
For analyzing the

arguments.
At the

integrated

Gol
dberg

real

and

financial

(1993)

effects of exchange rate

Correl
ation

capital

market

national

level,

analyses of
exchange rate moves often

movements.

rely

on

weighted

aggregate

trade-

exchange

rates.

However, aggregate indexes can

be less effective than industryspecific indexes in capturing
changes in industry competitive
conditions induced by moves in
specific bilateral exchange rates.
6

Aja

To examine

the

Error

An increase in aggregate

yi, R. A.

intertemporalrelation

Correction

domestic stock price has a

&Moug

between stock indices

Model

negative short-run effect on

oue M.

and exchange rates for

(ECM)

domestic currency value. In the

( 1996).

sample

of

eight

long run, increases in stock

advanced economies

prices have a positive effect on

domestic

currency

value.

Currency depreciation has a

negative short-run and long-run
effect on the stock market.
7

Dr.

To

study
of

the

Auto-

Exchange rate fluctuations

Yaw-

impact

exchange

Regressive

of the current term impose

Yih

rate fluctuations upon

Conditiona

significant impact upon stock

Wang

rate of return on the

returns in that industry. Market

MNC company stocks

Heterosced

average

and operating profit of

asticity

negative impact upon stock

returns

imposes

the MNC company.

8

Ah

study

the

Datast

med,

exchange rate exposure

ream

Abdel

of UK non-financial

Salam

companies

O. &

January

Ala
9

To

(ARCH)

1981

to

Higher percentages of UK
non-financial

companies

are

Worldscop

exposed

exchange

rate

changes than those reported in

Databases

previous studies.

to

December 2001.

traby A.
Gas

To study at the

ton

impact

Fornes
&
Gui

from

and

returns.

that

Qualit
and

have been exposed to exchange

unanticipated changes

quantitativ

risks in rising markets will

in the exchange rate,

e analyses

achieve its flexibility when they

specifically

the

&

decide

that

series

functional approach for the

regression

evaluation

llerm

currency

crises

Cardoza

took place in Latin

(2009)

America between 1998

ative

Foreign corporations that

time

to

choose

cross-

and 2004, had on the

value

of

Spanish

companies operating in
this region.
1
0

Jui-

To

study

the

Time

The

market

share

Chi

impact of prospect on

series

mechanisms are weakened by

Huang

the

techniques

exchange rate expectations in

Tantatap

mechanism

e
Brahma
sren
(2003)

market

share

open economies.

CHAPTER 3
METHODOLOGY

FINANCING

H
FOREIGN
EXCHANGE
INVESTMENT

H2

H3
RETURNS

3.0 Dependent variable

Foreign exchange

3.1 Independent variables

Financing, investment and returns.

3.2 Number of samples

Five until ten MNC in automotive industry.

3.3 Places and sample period

This research will focus on MNC in automotive industry through the world. Sample
period for this research is from 1970 until 2014.

3.4 Sources of data

Articles, newspaper and others secondary data from library.

REFERENCES
Aizenman, J. "Exchange Rate Flexibility, Volatility and Patterns of Domestic and
Foreign Direct Investment," International Monetary Fund Staff Papers vol.39 no. 4
(1992) 890-922.

Ajayi, R. A. &Mougoue M.( 1996). On the Dynamic Relation Between Stock Prices
and Exchange Rates. The Journal of Financial Research.19(2), 193-207.

Blonigen, Bruce. Firm-Specific Assets and the Link Between Exchange Rates and
Foreign Direct Investment. The American Economic Review, Vol. 87, No. 3.
(Jun.1997), pp.447-465.
Cushman, D.O., "Real Exchange Rate Risk, Expectations, and the Level of Direct
Investment,"Review of Economics and Statistics vol.67 no. 2 (1985) 297-308.
Froot, K., and J. Stein, "Exchange Rates and Foreign Direct Investment: An Imperfect
Capital Markets Approach", Quarterly Journal of Economics (1991) 1191-1217.
Goldberg, L., "Exchange Rates and Investment in United States Industry", Review of
Economics and Statistics vol. 75 no.4 (1993) 575-588.
Yaw-Yih Wang, Fluctuations of Exchange Rate on the Valuation ofMultinational
Corporations as Taiwans Samples, http://www.jgbm.org/page/23%20Yaw-Yih
%20Wang.pdf
Huang, J. C., & Brahmasrene, T. (2003). The Effect of Exchange Rate Expectations
on Market Share. Managerial Finance, 29(1), 55-72,

El-Masry, A., Abdel-Salam, O., & Alatraby, A. (2007). The exchange rate exposure of
UK non-financial companies. Managerial Finance, 33(9), 620-641,

Forns, G., & Carzoda, G. (2009). Foreign exchange exposure in emerging markets: A
study of Spanish companies in Latin. International Journal of Emerging Markets,
4(1), 6-25.