MANAGEMENT OF FOREIGN DENOMINATED ASSETS UNDER FLEXIBLE EXCHANGE RATES: A PORTFOLIO APPROACH

This study was undertaken to investigate possible alternative methods which a financial manager may use to reduce the risk inherent in multinational operations. The move from fixed to flexible exchange rates has caused corporations to become more cognizant of domestic and international economic conditions. Where the terms of exchange were fairly certain under the fixed rate system, the advent of flexible, or "floating", rates of exchange brought about an additional degree of uncertainty, increasing the possibility of greater risk in foreign operations. In an effort to reduce the added uncertainty of future rates of currency exchange, firms traditionally conducted some form of hedging operations to offset an exposed position in a particular currency with an equal and opposite closed position. The hedging operations would often be undertaken on the basis of perceived risk which generally resulted in a patchwork of closed and open currency positions. In undertaking selective hedging operations, usually far in advance of actual termination of a foreign contract, the firm would have to rely on its ability to forecast accurately and consistently the rate and direction of future rates of exchange.;The results of the factor analysis were then used with the aid of a non-linear goal programming algorithm in order to develop four efficient portfolios of six international securities. Empirical accounting data from a medium-sized multinational firm were used to illustrate the validity and feasibility of reducing exchange rate risk, first by presenting the accounting data as reported by the firm, and then by recasting such data in terms of the portfolio effect. The results indicate that it was not possible to eliminate currency losses for each year. However, on the average, the firm would have realized a gain on currency transactions over the period investigated through the use of an internationally diversified portfolio.;The results of this study suggest that the financial manager may attain a reduction in the risk of multinational operations by developing internationally diversified portfolios. International data for analysis are available from public sources; packaged computer programs are available for data reduction; and domestic portfolio balancing techniques may be used to adjust and to supplant portfolios dominated by foreign assets.;The purpose of this study is to provide the financial manager of a multinational firm with an alternative to currently practiced foreign exchange hedging methods used in exchange rate risk reduction. An empirical analysis was undertaken to provide a basis for this. Weekly data were collected for seventeen international variables representing seven nations plus the Eurodollar deposit rate. The data were collected for the period starting January, 1974 through September, 1978 and were transformed into rates of change of the seventeen variables. Principal Components factor analysis was performed on the data (1) to reduce the data to a form applicable to portfolio development and (2) to determine the degree of apparent international investment market integration.