Hedging Strategies For Protecting Mining Profits In Manchester City’s Forex Market


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Hedging Strategies For Protecting Mining Profits In Manchester City’s Forex Market

Hedging Strategies For Protecting Mining Profits In Manchester City's Forex Market

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By Khalil Nimer Khalil Nimer Scilit Preprints.org Google Scholar 1, * , Mahmoud Nassar Mahmoud Nassar Scilit Preprints.org Google Scholar 2 , Naser Abu Ghazaleh Naser Abu Ghazaleh Scilit Preprints.org Google Scholar 1 and Abdulhadi Ramadan Abdulhadi Ramadan Scilit Preprints.org Scholar 3

Received: 9 September 2020 / Revised: 25 October 2020 / Accepted: 26 October 2020 / Published: 29 October 2020

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This study provides additional evidence and insight into transaction exposure theories as it empirically examines the magnitude of transaction exposure in Kuwait, a developing country. Specifically, it investigates factors that may influence Kuwaiti firms’ responses to their transaction exposure and how being a family business or part of a family business group may play a mediating role in this the response. By conducting a questionnaire survey with the largest 147 industrial and commercial firms of Kuwait, the results of multinomial logistic regression indicate that the theories on financial hedging appear to be not applicable in the case of Kuwait . However, these theories provide only partial explanations for management behavior in response to Kuwaiti companies’ transaction exposure. The findings show that a firm being part of a family business group is significantly correlated with its level of hedging, suggesting that firms that are members of a family business group are expected to save at a higher level. This points to other theories, such as institutional theory, as having greater roles in explaining the transaction exposure behavior of firms in developing countries, and also suggests that family-controlled businesses are expected to engage in more innovative financial strategies and save at a higher level. . The research findings imply that Kuwaiti firms need to be more aware of their transaction exposure and pay more attention to related issues. Training programs in risk management strategies should be provided to decision makers to help them evaluate the hedging strategies they employ. This study shows how different risk behaviors exist between firms operating in developed and developing countries, including the effect of being part of a family business resulting in firms engaging in more financial strategies innovative when dealing with risk.

Between 5 January 2002, and 19 May 2007, the Kuwaiti dinar (KD) was pegged to the US dollar (USD) at an exchange rate of KD 0.29963 per USD 1 , with a margin of plus or minus 3.5%. The adoption of a link policy between the KD and the USD aimed to protect Kuwait’s purchasing power and limit the inflationary pressures that were affecting the local economy. However, following the depreciation of the USD against major currencies during that time, the Central Bank of Kuwait decided, on 19 May 2007, to link the KD to an undisclosed weighted basket of international currencies of Kuwait’s main commercial and financial partner countries [1]. After this transition, Kuwaiti exporters and importers were fundamentally exposed to higher levels of transaction exposure, whereas before this decision, they were immune to fluctuations in the USD due to the policy of pegging

In response to this transaction exposure, Kuwaiti firms used a wide range of hedging strategies and instruments, such as the use of money market hedging techniques or currency derivatives in -form of forwards, futures, options or currency swaps. However, there is no empirical evidence in the literature documenting the use by Kuwaiti importers and exporters of currency derivatives or hedging strategies to manage their transaction exposure to the risks of currency fluctuations. This study provides new evidence and insight into transaction exposure risk management (TERM) theories as it examines the magnitude of transaction exposure faced by Kuwaiti firms, the -the way these firms deal with this risk, and the factors that can affect their hedging levels.

Hedging Strategies For Protecting Mining Profits In Manchester City's Forex Market

International Accounting Standard (IAS) 21 defines two types of accounting exposures to exchange rate risks: transaction exposure and translation exposure. The first concerns the entry and exit of foreign money that is denominated in foreign currencies and that can create accounts receivable or accounts payable denominated in a foreign currency in the records of a commercial entity [2]. The latter results from the need, for the purposes of reporting and consolidation, to adjust the financial statements of the subsidiaries from the foreign currencies involved to the local currency [3].

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For the purpose of this research and in the context of the Kuwaiti environment, it is more appropriate to investigate the transaction exposure of Kuwaiti firms. First, typically, the maturity date, amount, and currency of the transaction are known by the firm. Therefore, for firms, the management of this form of currency risk is quite simple. In this context, Chow et al. [4] emphasize that transaction exposure, especially from commitments such as receivables and payables, is typically considered simple in terms of valuation and hedged. Second, in 2018, Kuwait reported exports and imports valued at USD 79.77 billion and USD 61.65 billion, respectively [5]. Oil represents 95% of Kuwait’s exports, and these originate under the umbrella of one governmental company. Accordingly, most private Kuwaiti companies are importers from countries such as the United States, Europe and China. This makes these companies highly exposed to foreign currency transactions.

Third, the act of managing translation exposure is criticized on the basis that this action is taken purely as a result of paper gains and losses. Bartov et al. [6] argue that the gains and losses resulting from translation exposure do not necessarily represent changes in the real costs or revenue streams of a firm, and, therefore, this is inconsistent with the concept of ‘ value maximization in financial theory. In this context, Redhead [7] notes the following:

It is sometimes argued that translation exposure is unimportant and that firms should not attempt to hedge this form of exchange rate risk. The reasoning underlying this view is that the movement of the exchange rate, relative to the currency of the country of origin, does not reduce the profitability of the foreign currency of the foreign investment. (P. 2)

In addition, Grant and Soenen [8] attribute the basic problem of accounting exposure to the fact that book values ​​have little relationship with shareholder wealth maximization. At the empirical level, Pramborg [9] examines the value effect from different aspects of accounting exposure in relation to hedging activities and foreign operations. Findings from a sample of Swedish firms, over the period 1997 to 2001, suggest that there appears to be a positive value effect associated with hedging transaction exposure but hedging translation exposure does not add value. Hagelin and Pramborg [10] investigate Swedish firms’ use of financial hedges against transaction and translation exposure. Their survey responses indicate that more than 50% of the firms in the sample employ financial hedges and that transaction exposure is hedged more often than translation exposure.

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Belk and Glaum [11] survey the 17 largest manufacturing companies in the UK and find that transaction exposure is the focus of UK multinational firms, while the exposure of translation attracts less attention. Batten et al. [12] surveyed the 500 largest Australian firms to examine their reactions to accounting exposure. The empirical results of their study indicate that transaction exposure is the most relevant risk faced by Australian firms, while these firms do not consider translation exposure to be important. Fatimi and Glaum [13] examine the response of German multinational firms to accounting exposure and find that 62% of these firms encourage the exposure of their transactions while only 17% of respondents manage b actively exposing their translation.

Despite these findings, some authors [3] argue that paper gains and losses due to translation exposure still need to be hedged because they have an effect on tax payments and, consequently, the -disbursement of money. In fact, this argument is valid in most countries but not in Kuwait or in the context of the Gulf countries where income tax is almost zero. Consequently, this type of accounting exposure is not expected to be the focus of Kuwaiti companies.

Fourth, only parents of foreign subsidiaries experience translation exposure; therefore, it would be impractical to examine translation exposure due to the

Hedging Strategies For Protecting Mining Profits In Manchester City's Forex Market

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