The purpose of this research is to examine the foreign exchange risk exposure of listed companies on the Karachi Stock Exchange (KSE) over the period January 2005 to December 2009. The research uses different exchange rate measures namely; the rupee to US dollar, the rupee to UK pound sterling, and the rupee to the euro to determine the degree of exposure. The data for this study involved 40 listed firms on the Karachi Stock Exchange. Monthly share price information for the period January 2005 to December 2009 required for the study were obtained from the Karachi Stock Exchange (KSE). The currencies are chosen which are widely used in international transaction in Pakistan. Salifu (2007) describes that how the exchange rates were computed as the ratio of the number of local currency which purchased a unit of foreign currency. These were the rupee to US dollar, the rupee to euro and the rupee to UK pound. These exchange rates were obtained from the State Bank of Pakistan.
The literature supports that exchange rate exposure affect the value of the firm. It affects positively or negatively on the profitability and the value of the firm. This is describing in the estimation process in terms of the stock returns of the firms. Therefore, the model shows that the exchange rate exposure has regressed the exchange rate on the return of the firm.
In this study, the model is adopted from Jorion (1990). This model is adopted because it incorporates the market exposure which controls for the market’s own exchange rate exposure. According to Bodnar and Wong (2000) this is the most applied and preferred model by researchers. The model describes the following relationship among the exchange rate changes, return on a firm and return on the overall market:
Rit = αi+βi1PUSD+βi2PUKP+βi3PEURO+δiRmt+εit (1)
αi = the constant term;
Rit = the stock return of firm i at period t;
Rmt = the return on the market;
PUSD = the percentage change of the US dollar relative to the rupee;
PUKP = the percentage change of the UK Pound Sterling relative to the rupee; and
PEURO = the percentage change of the Euro in relation to the rupee.
δi and βi represent the sensitivity of company it’s returns the returns on the market and exchange rate movements respectively. A positive βi indicates that a firm’s stock returns depreciate with a appreciation in the value of the foreign currency, whilst a negative βi denotes that stock returns fall with a appreciation in value of the foreign currency.
The returns for firm i for each period t was computed as equation 3:
Rit = Pt –Pt-1
Rit = the holding period return in time t of asset i;
Pt = the share price of firm i at the end of period t (as at the first day of the second; and subsequent months of trading); and
Pt-1 = the share price of firm i at the end of period t 2 (as at the first day of the first trading month).
Equation (1) is run separately...