Is exchange rate risk relevant?

date_range 21-Mar-2023
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Some claims have been made that the currency rate risk posed by MNCs should not be considered. MNCs do not care about the chance since they think they can manage and stabilize it. Let's look at the arguments since there is a counterargument that currency rate risk may be significant for MNCs.

Currency diversification argument 

Another argument is that if a U.S.-based MNC is well diversified across numerous countries, its value will not be affected by exchange rate movements. In other words, if multination global companies got the cash flow in various currencies, then the up of one currency of exchange rate could be offset by the down of another exchange rate, which means that the exchange rate risk is irrelevance. 

However, there is also a claim that exchange rate risk is relevant to MNCs due to Exchange rate effects on an MNC will not be offsetting because exchange rate movements of many currencies against the dollar are in the same direction over a specific period. We can rarely see the value of each currency is equal. So, it is unrealistic to presume that exchange rate effects will offset each other just because an MNC has transactions in many different currencies. Therefore, an MNC must recognize exchange rate risk, even when it has cash flows in numerous currencies. 

 The Investor Hedge Argument: 

One Argument for exchange rate risk to be irrelevance is that investors in MNCs can hedge their own risk. In other words, exchange rate risk is real and opposes a problem for the company. Still, instead of the company engaging in the hedging transaction, an individual investor can use the forward contract hedging method or another option.

Still, the question is whether investors are informed and experienced enough to understand the financial situation within the corporation, which they probably don't know and don't know how to measure a firm exchange risk, what strategies are available to manage risk, and how to implement them to their advantage. 

In most cases, individual investors prefer corporations hedge for them. MNCs believe the exchange rate risk is relevant and can hedge at a lower cost than individual investors. , MNCs have more information about their exposure and can hedge effectively to their advantage, which is why investors prefer MNCs to hedge for them.

Source: University of Sargodha