Foreign exchange rate exposure and determinants of using foreign currency derivatives: An empirical study on public listed firms of Malaysia

Financial theory holds that fluctuations in exchange rate significantly influence open market firms by affecting their cash flows and firm value. Because of high market openness and fluctuations in Malaysian exchange rate, this study, therefore, aims to investigate the extent to which 224 sampled firms of Malaysia face foreign exchange risk during the period of 2008 to 2014. Similarly, the continuous improvement in derivative market structure has enabled corporations to effectively manage their foreign exchange risk by using a variety of financial hedging tools such as foreign currency derivatives (FCDs). Therefore, the second aim of this study is to investigate the extent of the influence of foreign exchange risk and other firm’s characteristics on the use of FCDs. This study employs ordinary least square model and logistic regression model to achieve first and second aim of the study respectively. Results show that the fluctuations in exchange rate significantly affect Malaysian firms’ value during
the sample period. It is also found that hedging pattern of Malaysian firms is significantly explained by the foreign exchange risk. The findings reveal that financial distress, firm size and exposure to foreign business operations significantly affect FCDs use. However, the study finds no support for risk management committee, underinvestment theory and liquidity hypotheses in explaining derivative use. This study contributes to relevant literature by introducing two new variables: foreign exchange rate exposure and risk management committee; using new market index and estimating both total and residual exposures. The results have implications for managers by guiding them to carefully consider highly risky currencies while making international transactions. This study has also implications for investors by guiding them regarding investment decisions; for Bursa Malaysia Derivatives Berhad in relation to offering new or improve existing derivative products and for Malaysian government to
formulate risk management strategies at national level.