Foreign Exchange Risk Exposure on Toyota Motors

conflicting permute encounter vulnerability on Toyota MotorsThe globalisation phenomenon aloneows companies to transnationally expand their sales and production activities. A consequence of this phenomenon, however, is the humans of abroad shine judge film which tidy sum disturb the clubs profitability, shed light on hard cash electric current and commercialise prizes. In the past years, several(prenominal) academician researches hire been true in put together to explain and prove how immaterial transmute take chances characterization fluctuations match a transnational corporation or a purely domestic social club mensu tread, and how this jeopardize is lickd by the alliances seek focussing st arrangegy. Consequently, this sermon aims to find around knowledge on these subjects for a specific alliance, Toyota Motor Corporation.By applying the capital securities industry commence and analyzing trey diametrical periods, it is possible to co nclude that Toyota Motor Corporation, in a crisis situation, was open to protect itself against some of the primary qualify contraryiates fluctuations it is expose to. Thus, the predictability of higher fluctuations allows the conjunction to apply exploitive riskiness of infection management strategies.Considering a ten year period, bilateral tack rate fluctuations ar to a greater extent signifi micklet to the caller-out line of merchandise returns than for opposite periods. However, being an exporting comp both, its coefficient for picture is non make upent with the belligerent gain an exporter holds when its company home property depreciates. It is consistent, however, when the broad up-to-dateness index is take uped. Additionally, the contact of ir pertinent re-sentencing risk fluctuations is small for company transmission line returns. This do- nonhing thus indicate that supercede rate fluctuations dont nominate a signifi fundamentt impact on compan y stock damage returns.INTRODUCTIONThe globalization phenomenon has allowed the integration of national economies into the external economy, giving them easier access to information, goods and services through trade and distant propose investment around the world. This process has been encouraging an increasing military issue of companies to nonplus operating on a global scale, expanding their networks worldwide. In new years, the number of international companies has gr take in in ordain to respond to the competitiveness undergo in the domestic market and explore new markets to produce or sell new products and services. Multinational companies, or purely domestic companies with a broad network, atomic number 18 exposed to several risks. An great risk that has a signifi washbasint impact on the management of a company is the hostile central risk, out-of-pocket to the fact that it whitethorn affect the companys cash flows, stinting value and performance. Nevertheless, be sides the remote transposition risk, many other risks affect companies, much(prenominal) as the bear on rate risk. Several monetary and operating instruments and techniques atomic number 18 being subroutined and developed by multinational companies to wield these risks. However, in order to manage these risks, companies must know exactly what their risks be and how to bar them.With regard to unusual kind over rate exposure, several studies conducted in recent years have presented various risk management approaches in order to understand to what extent its fluctuations affect the companys value and performance. However, there is little consensus among the several(predicate) studies, which indicates that swop rates ar complex and flock affect and be abnormal by unlike factors. The roughly conventional approaches atomic number 18 the cash flow approach and the capital market approach. In this turn over, the capital market approach is customd to assess, through decimal methods, to what extent orthogonal alter rate fluctuations affect the companys value. It is important to note that several studies using valued methods comprise no statistical signifi rearce when trying to understand the impacts of unconnected exchange fluctuations on the companys value. Thus, an account given for this fact was that the company was able to protect itself against extraneous exchange rate fluctuations by kernel of table instruments and techniques.The chief(prenominal) purpose of this study is to analyze the outside(prenominal) exchange risk exposure of a multinational company using the capital market approach, and as well as to what extent the various assumptions underlying this approach produce different imports. The choice of the multinational company was base on the following requirements it had to be a public company operating in a competitive industry and could not be the subject of any other study in the analogous area. Accordingly, the To yota Motor Corporation was chosen. Its main plants are dictated in Japan it operates in the Automotive Industry and was the worlds large-mouthedst manufacturer in 2009. Further to a greater extent, 61.4% of sum up sales to external costumers are overseas, which indicates that the company is interchangeablely to stage considerable impacts from hostile exchange risk exposure.In order to bring home the bacon the main purpose of this study, Toyotas foreign operations are analyzed in a first phase to understand to what extent the company is internationalistized. Moreover, this initial analysis as well as envisages the foreign exchange rate fluctuations against the companys stock price returns and their direct impact on its report accounts, as rise as the hedgerow instruments put ond to handle the foreign exchange risk.In a second phase, the capital market approach is used to suggest that foreign exchange risk exposure could be postingd as the sensitiveness of stock price re turns to exchange rate movements. This approach requires the implementation of statistical regressions. For this purpose, market, stock price and foreign exchange rate data were pile up from 1999 to 2009. Considering the studies developed by different authors, regressions involve several hypotheses for the exchange rate variable stars, such as a Nominal Broad Index that is like a basket of currencies and several bilateral exchange rates, in order to understand which variables affect stock price returns. In this second phase, the quantitative method is applied to three different periods in order to analyze how the company handles the foreign exchange risk. As this disquisition takes into account the investors localize of view, it can help to understand how investors determine and quantify the exposure of their portfolio to the foreign exchange risk. Moreover, this approach allows comparing the companys exposure to foreign exchange rate fluctuations with that of competitors in ord er to understand the effectiveness of the hedging activities.To complement this study, this dissertation is organized under the following dividesThe first subdivision is a constitutional review of the literature on this subject. It explains why it is important that companies know how to handle the foreign exchange risk and presents the findings of past research.In the second section, the traditional categories of foreign exchange risk exposure are described, the effect of hedging the foreign exchange risks are shown and the most used analysis methods are discussed.The third section provides an overview of Toyota and an analysis of its foreign operations. The main purpose of this section is to support the interpretations that emerge from the regression results and this information is used as the alonet for selecting the variables for the regression model.In the fourth section, relevant analyses are provided about the variables that may be a source of risk for Toyota and which w ere chosen for the regression model. In addition to this, it presents the hedging programs undertaken, the designated and undesignated fiscal instruments used and the reasonablenesss why the company does not need to have fiscal instruments to hedge definition and economicalal exposure.The fifth part section describes the methodology used. The reasoning, as easily as the issues of each variable entangled in the model, is expressed in this section. It also presents the study piece periods and data sources. In addition to this, it provides an analysis of the descriptive statistics for the data and different periods used in the model.The sixth section contains the regression results and provides an analysis and explanation of the findings. It also presents the limitations of the software used for the regressions and a brief analysis of the foreign exchange risk exposure of Honda and Nissan Motor Corporation.The seventh and last section summarizes the main conclusions of this stu dy and presents some suggestions for further research.LITERATURE REVIEWThe coating of creating a global business has, in the past years, been the fundamental reason behind the growth of multinational companies. Such an example is the registered growth in Japanese companies exports. In 2000 and 2009, exports from Japanese companies amounted to 0.8%1and 10.8%1 of the GDP, respectively. An annual growth of 32.9% in foreign activity, for a nine year period, is one of many advantages that companies can obtain by opening themselves in many ways. Other advantages implicate the opportunity to modify labor force, to enter new markets and sell more, to put down transport cost and to benefit from economies of scale. This, however, also creates new problems, challenges and demands.A multinational company is either a company with operating subsidiaries, branches or affiliates in more than one verdant, or a purely domestic company engaged in international activities (imports and exports). rough of the new problems and challenges these companies face complicate an increased exposure to foreign risks, such as exchange rates, interest rates and commodity prices Miller, 1998. Moreover, the risks associated to exchange rates appear do to the linkup with new currencies2. Exchange rates constitute one of the most important macroeconomic risks, which can potentially impact, positively or negatively, the companies profitability, cash-flows and market value, due to exchange rate fluctuations. Consequently, in order to handle exchange risk exposure, companies can adopt several hedging tools.In the past decades, give thanks to the increasing number of international trade activities and multinational enterprises, as well as the large coin fluctuations registered, the volume of research that tries to footfall and analyze the impact of exchange rate fluctuations in multinational companies and their vulnerability to it has grown. However, produced results/conclusions have a mi ngled nature due to the complexity of this subject.The main death in this section is to understand, through previous researches, what eccentrics of companies are most affected by exchange risk exposure, the importance of hedging, several types of foreign exchange risk exposure, types of hedging activities depending on the foreign exchange risk exposure the company is facing and traditional approaches to measure exchange risk exposure.Exchange Risk Exposure of Multinational Companies vs. Domestic CompaniesThanks to the phenomenon of globalization, as well as the increase in companies foreign activities, several researches have been developed in order to give some input on what type of companies show a higher exchange risk exposure multinational or domestic companies.The results of previous empirical studies suggest that totally authorized industries and/or companies are exposed to foreign exchange risk5. In the other hand, even a purely domestic company with importation or expor ting activities is impacted by fluctuations in exchange rates. This judgement is connected with competitive advantage for instance, the products an exporting company sells abroad can still affect the companys value due to the effect of exchange rate fluctuations in competitors, suppliers and in customers demands. Muller and Verschoor (2006) concluded in their study that a companys size is also an indicator of its foreign exposure. They found that a companys disdain dividend payout ratio results in a stronger short-term liquidity position and, consequently, a smaller hedging motivation and a higher exchange risk exposure.Other authors however, such as Choi and Jiang (2009), defend that multinationality is important for a companys exchange exposure, but not in the popular notion that was mentioned. Some authors found evidences that foreign exchange risk exposure is actually higher and more significant in absolute magnitude for domestic companies, when compared to multinational compa nies. The real explanation for this finding is the fact that multinational enterprises are more exposed to effectively and easily use financial hedging and operational hedging in order to lessen their position against foreign exchange risk, and also to increase their stock returns. Additionally, these companies are more aware of foreign exchange risks. Dominguez and Tesar (2006) agree with this finding and they also found that small companies, rather than large and medium-sized companies, show a higher exposure due to the same reasons. As a result, companies that dont engage directly in international business but compete against foreign companies can be affected by exchange rate fluctuations Dominguez, Tesar, 2006. Dominguez and Tesar (2006) also found that the industry level may influence exposure. They suggest that exposure increases in highly competitive industries. In more competitive industries, however, an almost perfect pass-through can be expected since they are more awar e of their vulnerability and are consequently get around move to hedge foreign exchange risks, when compared with less competitive industries6.Regarding purely domestic companies, Pritamani, Some and Singal (2005) found that importing companies are more affected by fluctuations in exchange rates than exporting companies. Therefore, companies with importing activities should have more reasons to hedge exchange risk exposure.The Importance of hedging Exchange Risk ExposureHedging means taking a position when getting a cash-flow, an asset or a contract in order to protect the owner from losings and to eliminate any gain in the position hedged. Several researches indicate that currency risk management is genuinely important to manage earnings and unexpected losses. Consequently, this should be done in order to disgrace any impacts on the stockholders equity and to prevent value declines for the equity holder due to cash flow changes and unfavorable exchange rate fluctuations, respe ctively. Hedging currency exposure can therefore reduce some of the expected fluctuations in rising cash flows and increase their predictability Smith and Stulz, 1985.It is believed that foreign exchange rate fluctuations impact financial decision-making in production, marketing, planning and dodge Moffett and Karlsen, 1994. It is therefore necessary to make contingent investments or develop semipermanent strategic plans and management perspectives in order to understand the volatility of foreign exchange. Companies can implement hedging tools based on policies that define when and how to hedge against foreign exchange risks. Hedging tools are not static mechanisms, companies are able to dynamically adjust their behavior in response to foreign exchange risks for instance, a company can find out to hedge only part of their foreign exercises. To undertake these policies, the company necessarily to determine its risk tolerance and needs to understand the direction that the currenc y to which it is exposed is promising to take.A value maximization corporation that hedges its exposure to exchange risks can reduce the costs connected to financial distresses and taxes, as well as agency problems existing betwixt coverholders and bondholders Martin and Mauer, 20057. A possible reduction of financial distress costs allows investors to require lower risk premiums. Consequently, the company value increases Smith and Stulz, 1985. Therefore, as mentioned by Smith and Stulz (1985), hedging is part of the overall merged financing policy.Moreover, Dumas and Solnik (1995) concluded that part of the return rate of an assets price is influenced by the foreign exchange risk premium. Thus, when a company implements risk management activities that decrease its foreign exchange risk exposure, the cost of capital is bring down.Some authors sustain that exposure management may not reduce total risk. Copeland and Joshi (1996) contendd that anticipating hedging strategies is d ifficult given that so many other economic factors change when foreign exchange rates fluctuate. This is confirmed by Moffett and Karlsen (1994), who argue that the uncertain nature of emerging cash-flows hinders the implementation of commodious-term strategic plans and better investment decisions.It is also argued that risks connected to an inefficient hedging activity can increase exposure Hagelin and Pramborg, 2004. Additionally, currency risk management usually consumes some of the companys resources, consequently lowering its expected cash-flow Eitman, Stonehil and Moffett, 2010. Therefore, companies need to know whether their hedging strategies are successful or not, and if they are relevant to shareholders Hagelin and Pramborg, 2004.Findings regarding the Vulnerability of Multinational Companies to Foreign Exchange Risk ExposureHedging tools that handle exposure to foreign exchange risks are not simple and they dont hold only a few complexities, since the companys exchange risk exposure correlates with its size, multinational status, foreign sales, international assets and competitiveness and trade at the industry Dominguez, Tesar, 2006.Adler and Dumas (1984) suggested that a companys foreign exchange risk exposure can be measured by the stock prices sensitivity to unexpected foreign exchange rate fluctuations. On the other hand, it could also be measured as the companys cash flows sensitivity to foreign exchange rate fluctuations. Considering that the main goal of this dissertation is to analyze economic exposure, it is important to note that several authors have developed researches that try to measure and analyze unexpected impacts of exchange rate fluctuations on companies performances, portfolios and Industries. Nevertheless, these researches have produced mixed empirical results.Jorion (1990) found that only 15 of 287 US multinational companies were statistically significant concerning the impacts of exchange rate fluctuations in companies stock returns. Additionally, the author spy that higher company foreign operations strikeed higher exposure to exchange risks. Nevertheless, Bartov and Bodnar (1994) found that 208 of the companies with foreign operations that composed their sample were not statistically significant to the effect of US exchange rate fluctuations on companies stock price returns.Additionally, other researchers have reached mixed conclusions using different methodologies, samples and alternatives for the main variables. The inconsistency in these results, therefore, doesnt allow a sustainable conclusion on this subject. Recent studies, however, found evidences that exchange rate fluctuations do have an impact in companies performances. Such an example is the research developed by Dominguez and coquette (2006), who found exposure to be statistically significant due to the effect of exchange rate movements on stock returns at Industry and country level.Some explanations have been pointed out by several au thors for these mixed results. The registered contradiction can be explained by limitations concerning data, variables and methodologies used. Different researches develop different alternatives in order to determine foreign exchange risk factors and company values, which include different samples, the use of companies with less exposed economies (USA) or more opened economies and different periods all of these affect research. Bartram (2008) also explains that the use of stock returns to measure company value reflects the hedging position of companies, and the analysis is thus considering a lower level of risk exposure. Crabb (2002) also suggests that these mixed results can reflect different financial hedging strategies on data or evidently reflect noisy data. Additionally, Bartram and Bodnar (2007) found that operational hedging activities help companies reduce their exposure and, consequently, have no statistical significance over the impact of foreign exchange rate fluctuati ons on companies returns. Therefore, as suggested by Crabb (2002), a statistically non significant exposure to exchange rates can result from an efficient hedging strategy set in place by the company.Types of Foreign Exchange Risk ExposureThe hedging decision depends basically on the level of risk exposure, its magnitude and the magnitude of hedging that companies obtain necessary. Companies should essentially hedge activities that put them in a position with a high level of uncertainty, i.e., risk exposure in the strategy dramaturgy (competitive, input supply, market demand and technological risk) and fields of interest to finance and international business scholars (foreign exchange risk), Miller, 1998.Before initiating the hedging process, the company has to decide what exchange risk exposure to hedge and how. There are three traditional foreign exchange rate exposure categories8that impact companies and that have a specific managing method the transaction exposure, the operat ing exposure and the translation exposure. Generally, these exchange risk exposures can be hedged through the use of derivatives and financial instruments, such as commodities, futures and forward contracts, options and swaps Miller, 1998.The main goal of this dissertation is to measure and to analyze how unexpected foreign exchange rate fluctuations affect a multinational company. Notwithstanding it is also important to understand how the other two types of exposure impact companies and the types of hedging mechanisms available to handle exposure, in order to reach a deeper analysis and optimal conclusions.Economic ExposureEconomic exposure, also known as operating exposure, is an unexpected change in exchange rates that affects the present value of the company by changing future operating cash flows, arising from inter-company and intra-company activities Eitman, Stonehil and Moffett, 2010. The unexpected exchange rate fluctuations affect the expected future operating cash-flows c hanging the volume, price and/or costs of future sales Moffett and Karlsen, 1994.Economic exposure approaches the impact of long-term currency exposure and analyzes the health of a companys business in the long run. The changes registered in the expected future cash flows depend of the change in the position the company holds in international competition10. Managing economic exposure involves all aspects of a company.Before establishing hedging policies, a company needs to measure its economic exposure. In order to do that a company should invest some resources in assessing its exposure, i.e., identifying the set of environmental contingencies affecting and relevant to the creation of shareholder value Miller, 1998. This identification allows the assessment of alternative environmental scenarios and consequent adoption of reformd strategic decisions by the company. This is the reason why identifying and measuring economic exposure can be complex and difficult, commission in mind t hat environmental contingencies vary crosswise industries and across companies indoors those industries. Moreover, some authors mention economic exposure as being subjective, since it is based in estimates of future cash flows.Hedging StrategiesThe main goal of economic exposure management is to anticipate and influence unexpected and unpredictable effects in exchange rates. This can be accomplished if a company diversifies and changes its international operating and/or financing policies. This diversity allows the company to oppose in an active or passive way.The company can diversify operations through sales, localisation principle of production facilities and raw material sources or inputs Eitman, Stonehil and Moffett, 2010. A company can expand its sales through subsidiaries distributed across different countries, bringing its products or services to new markets and taking advantage of economies of scale, being also capable of diversifying its exposure to foreign exchange ris ks. flexible management policies allowing a faster sourcing of raw materials and components can easily subside this exposure if this adaptation considers the impact of exchange rate fluctuations in the company costs and revenues. Additionally, RD can also mitigate this exposure, allowing the cutting back of costs and enhancing productivity as well as product differentiation.Choi (1989)11pointed out that international investment is one of the major instruments in managing economic exposure. In the same line, Miller and Reuer (1998) developed a study that showed this exposure is considerably reduced with a higher and direct foreign investment by the company (foreign market entry mode). Additionally, Smith and Stulz (1985) found that mergers achieve results that are homogeneous to hedging results. Consequently, a company may wish to diversify the location of its production facilities internationally in order to mitigate the effect of exchange rate movements. This mitigation is possi ble because the company measures its cash flows in different currencies. Thus, exchange rate fluctuations in all currencies the company is exposed to can be congenitally offset as can, consequently, the gains or losses while the company still reacts competitively.Diversification in financing is achieved by rhytidectomy funds in more than one capital market and in more than one currency12. This method allows the company to reduce future cash-flow variability, to increase capital availability and to reduce costs, as well several risks, such as political risks.Allayannis et. al. (2001) observed that companies with geographical dispersion are more likely to use financial hedging strategies to lower their foreign exchange risk exposure. Accordingly, the use of exclusively operational hedging does not increase the companys value. However, if companies combine operational and financial hedging they will improve their value and, consequently, reduce exposure to foreign exchange risks.Comp anies can also adopt proactive policies (including operating and financing policies) to offset anticipated foreign exchange risk exposures. These policies allow a partial management of this exposure. The most generally employed are13 matching currency cash flows, risk-sharing agreements, succeeding(prenominal) loans, currency swaps, leads and lags and reinvoicing centers. Eitman, Stonehil and Moffett (2010).Transaction ExposureTransaction exposure measures gains or losses resulting from unexpected changes in future cash flows already contracted in a currency-denominated transaction Martin and Mauer, 2005. The uncertainty stems from the impact of exchange rate changes on the consolidated financial reports Friberg and Ganslandt, 2007 and the fact that it is not anticipated in any line item of a financial statement Eitman, Stonehil and Moffett, 2010. Thus, the uncertainty can be the specific quantity of foreign currency or the clock of cash-flow Moffet and Karlsen, 1994.Transaction ex posure approaches foreign exchange risk exposure in the short-term. It is therefore easier to identify and to measure, allowing a greater effectiveness of hedging strategies to be expected.Hedging StrategiesThe exposure to foreign exchange transactions can be hedged by contractual, natural, operating and financial hedges. The company, however, needs to determine its own risk tolerance and its expectations concerning the direction the exchange rates will assume. contractual techniques include hedges in forward17, policies that imply proportional hedging.A natural hedge is basically an unhedged position where the transaction is left uncovered. Crabb (2004) suggests that this is not a very good hedge because it doesnt control variation over clock and, consequently, companies cannot perfectly hedge their exchange rate exposure.An operating hedge means that the company will simply create an off-setting operating cash-flow (account payables, for instance). This hedge can also be implemen ted through several techniques, such as invoice currency, leads and lags in payment terms and exposure netting Eun and Resnick, 2004.Hedging through invoice currency allows the company to shift its foreign exchange risk exposure, invoicing foreign sales in home currency, or share foreign exchange risk exposure18, pro-rating the invoice currency between foreign and home currencies. Additionally, a company can also diversify its exposure to foreign exchange risks by invoicing sales in a market basket index Eun and Resnick, 2004.By hedging with leads and lags companies can urge or decelerate the timing of payments (receipts) made (received) in foreign currencies. This hedging strategy is efficient if a currency is expected to appreciate or depreciate against another Eun and Resnick, 2004.Finally, the technique of exposure netting suggests that a multinational company should not consider its deals in isolation, focusing rather on hedging the company in a portfolio of currency positions . This means that companies should consider overall payments (receipts) that must be done (received) after taking in account the opposite operations that naturally hedge each other. To use this technique some companies have re-invoicing centers, separate corporate subsidiaries that serve the put up or related unit in one location and all foreign subsidiaries. The reinvoicing center receives the invoice between the subsidiaries, taking legal backup of the good that manufacturing plants sells to distribution subsidiaries of the same company, managing all foreign exchange transaction exposure for intracompany sales Eun and Resnick, 2004. Additionally, the reinvoicing centers can guarantee the exchange rate for future ordersand also manage intra-subsidiary cash flows Eitman, Stonehil and Moffett (2010).Financial hedging refers to the creation of an off-setting financial cash flow by either borrowing or lend in the currency the company is exposed to. The company can use some type of p roactive policies such as back-to-back loans and currency swaps.A back-to-back loan occurs when two companies in different countries organise themselves to borrow each others currency for a specific period of time. They then(prenominal) return the borrowed currencies at an agreed terminal date.By hedging via currency swap, the company and a swap trader agree to exchange an similar amount in two different currencies (for instance, a company enters a swap paying yens and receiving dollars) for a specified period of time. The swap dealer assumes the role of a middleman.A matching currency cash flow proactive policy can act like a financial hedge or an operational hedge. The first alternative to offset a long-anticipated and continuous exposure to a particular currency (i.e., the Japanese Yen) is to see debt in that currency (in Yens). Suppose the following exposure A US Corporation exports goods to a Japanese corporation. The inflow of the Japanese Yen creates a foreign currency e xposure. An hedging technique requires that the debt payments in Japanese Yens, which consist of the principal and the interests paid by the US Corporation