Exchange Rate Risk Management using Currency Derivatives: The Case of Exposures to Japanese Yen

Abstract

This paper focuses on managing exchange rate risk associated with a secondary, non-USD exchange rate of Japanese yen (JPY). Employing Korean firm data, our preliminary analysis reveals that Korean firms are exposed differently to changes in the KRW/JPY rate than to changes in the KRW/USD rate. Our results show that firms exhibiting significant shifts in exposure from pre- to post-global financial crisis have distinctively different firm attributes including more currency derivatives use and lower firm values, compared to firms exhibiting little such shifts. A further analysis reveals that the lower values of high exposure firms are attributable mainly to the financial risk from foreign currency borrowing, but not to the operating risk resulting from exporting activities. Hence, the currency derivative use by Korean firms hardly helps them mitigate the value loss from heightened capital costs of foreign borrowing following the crisis.