Aaltodoc publication archive (Aalto University institutional repository)
School of Business | Department of Finance | Finance | 2016
Thesis number: 14686
Currency risk management: A case study on hedging Russian ruble
|Title:||Currency risk management: A case study on hedging Russian ruble|
|Year:||2016 Language: eng|
|Department:||Department of Finance|
|Index terms:||valuutta; currency; valuuttakurssit; exchange rates; riski; risk; riskienhallinta; risk management|
|Key terms:||Currency risk management, hedging, currency rate, foreign exchange exposure, Russian ruble|
This thesis examines currency hedging from three perspectives: The thesis starts that with analyzing rationale and supporting empirical evidence on why companies should hedge and how it impacts firm value. It is a highly debated topic whether hedging increase firm value and the empirical evidence is not conclusive. Second, I review practical guidelines and measures that companies can use to improve their currency risk management programs. These guidelines and measures include 1 profile all risks surrounding the company, 2 hedge only what matters, 3 choose a hedging strategy that accomplishes the company's hedging objectives, 4 understand the total cost of the hedging program, 5 increase accuracy of cash flow forecasting, and6 look beyond financial hedges. These are very practical approaches and can be done with little pain, relatively low cost and fairly short order.
The last part of the thesis is the empirical case study. The case study was conducted by back-testing three distinct hedging strategies: currency forwards and vanilla currency options and zero-cost risk reversal. The testing is conducted with Company X's Russian ruble-denominated cash flow data from 2005 to 2015. The objective was to find an optimal hedging strategy to hedge this exposure and discuss the necessity of hedging this exposure in the first place. The performance of these strategies is evaluated from two perspectives: the economic results of the strategies and their ability to reduce unexpected negative results.
The results indicate that hedging would have been profitable during the study's time period with every strategy generating a positive result. The positive results were primarily driven by the extreme weakening of ruble in 2014 and 2015. Forward contracts outperformed the option strategies in both economic results as well as in reducing unexpected negative results. It's was also noticeable that the cost of hedging was significantly high, especially for the FX options due to the interest rate differential and volatility.
Based on the results, I would recommend considering not to hedge the ruble exposure due to the high cost of hedging in the prevailing environment. The Russian business represents only 1-2 percents of the total revenue and the ruble cash flow does not pose a risk to the case company's financial health nor strategic plans.
Master's theses are stored at Learning Centre in Otaniemi.