UK Foreign Exchange Rates IntroductionUnderstanding exchange-rate preferences and policies is a precondition for analyzing the issues that governments raise during negotiations over the rules of international monetary institutions. exchange-rate policy has become an increasingly important—and contentious—aspect of economic management because of the integration of national financial markets. The reasons have to do with the relationships among national monetary policy autonomy, stable exchange rates, and international capital mobility. Each of these may be a desirable goal in itself, but all three are incompatible with each other. Governments must choose among: • Monetary policy autonomy and fixed exchange rates with low international capital mobility, • Monetary policy autonomy and international capital mobility with varying interest rates and volatile exchange rates, or• fixed exchange rates and international capital mobility with low monetary policy autonomy.
(Holland, 2003, 210-16)With the increasing globalization activities, the foreign exchange rate risk becomes an important part management may have to think about. Foreign exchange rate risk seems closely related to firm cash flows volatility. In 2001, Allayannis and Ihrig’s theory (Allayannis and Ihrig, 2001, 805-35) suggested that firm cash flows volatility is determined by the nature of firms.
But because it’s difficult to analyze most firms’ cost structure, this way didn’t figure out the relationship successfully. Foreign Exchange Rates and Euro as DeterminantIn 1999, the Euro is introduced as a common currency used among Europe countries. It’s a hypothesis that a common currency could reduce transaction costs, and exchange rate risk. It’s because the trade across countries avoiding the dealing of foreign currencies, then both of traders do not suffer the unexpected foreign exchange rate changes. The transaction cost occurred during the dealing of foreign currencies is eliminated as well.
Then the relationship between foreign exchange rate and firm value could be observed through examining the affect of Euro on firms to check whether this hypothesis is feasible. In order to do so, there are three points need to be proved: After the launching of Euro, for many countries, stock market volatility increases. Compared to non-Euro countries and outside of Europe, those firms within Euro area due to higher exposure of Euro currency may experience lower increase. The introduction of Euro leads to the reduction of market risk, no matter this country is located in or outside of Europe.
This point may testify that the nature of foreign exchange rate is non-diversifiable. Even though incremental foreign exchange rate exposures appeared in some firms, actually net absolute decreasing foreign exchange rate happened in the left 90% firms. (Buckley, 2002, 161-63) Then Euro could be stated have impact on foreign exchange rate exposure, because it arose the reduction of foreign exchange rate exposure. Excluding the above 3 points, the market beta and foreign exchange rate beta of multinationals is turned out to be determined by the firm’s characteristics, which refers to total sales, and foreign sales take place in Europe.
Then the foreign exchange rate exposure reduced significantly for those multinationals with low total sales, but high foreign sales in Europe. In addition, geography and industry competition is relevant to foreign exchange rate beta as well. Compared to non-Euro Europe, market beta and foreign exchange rate beta in Euro area changed obviously larger because of the high exposure of Euro currency. High competition industries have larger reduction in foreign exchange rate beta than low competition industries.
The reduction of market beta and foreign exchange rate beta means that both the market changes and foreign exchange rate changes have smaller effect on firms. (Dufey, 2002, 51-57) The high exposure of Euro currency enables firm experiencing lower market risk, eliminating the cost of capital, more capacity bearing higher business risk, and increasing firms’ value.