The Case for Corporate Management of Foreign Exchange Risk

Abstract

* The objective of this paper is to present the case for corporate management of foreign exchange risk. The arguments that oppose hedging at the level of the firm can be summed up as follows: Foreign exchange risk does not exist; even if it exists, it need not be hedged; even if it is to be hedged, corporations need not hedge it. In support of the above reasoning, one or more of the following arguments are advanced. 1. The Purchasing Power Parity (PPP) theorem implies compensating changes in price levels and exchange rates; hence, there is no exchange risk. 2. The Capital Asset Pricing Model (CAPM) purportedly suggests that it makes no difference whether exchange risk is managed separately or passed along to the capital market; hence, even if exchange risk exists, it need not be hedged. 3. The Modigliani-Miller (MM) theorem implies

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