A STUDY TO DETERMINE THE EFFECTS OF FLOATING FOREIGN EXCHANGE RATES ON THE RISKINESS OF MULTINATIONAL ENTERPRISES

Research, performed prior to the collapse of the International Monetary Fund in 1973, suggests that there are benefits to multinational diversification. None of these studies have analyzed the impact that the new international monetary system has had on this relationship.;The results of this study indicate that multinational firms have become less risky, as measured by beta, while domestic firms have become more risky. These results are consistent when other factors such as industry, proportion of foreign sales, size of firms, and number of countries in which investments are made, are examined.;Now that the international monetary system has changed and foreign exchange rates are more volatile, the riskiness of multinational firms might be expected to be higher causing their betas to rise. The results of this study do not support this conclusion. Two reasons are posited for this. First, it may be that multinational firms are less risky because of other factors that have a greater impact on multinational firms than the change in the international monetary system. If the domestic environment has become more risky, multinational firms would be less influenced by these factors because their assets are diversified across countries and not all subject to these adverse effects. Domestic firms, which do not mitigrate against the increased domestic risk with foreign investment, must absorb the total increase in risk. This could explain why multinational firms have become less risky in absolute terms as well in relation to domestic firms.;A second possible explanation of the impact of the change in the international monetary system is the method by which foreign exchange rate changes are determined. Under the fixed rate system, the ultimate decision to change the foreign exchange rate was made in the political arena. Thus, although all economic factors might indicate that a foreign exchange rate parity change was necessary, for political reasons, no parity change would be made until the situation became so serious that a traumatic change would be required. Estimated foreign exchange rate changes would have riskiness with respect to economic predictions and uncertainty with respect to political changes. Under the floating rate system, the political impact and the uncertainty of that impact on exchange rates is reduced. Therefore, although foreign exchange rate changes are now more volatile, they are less uncertain.;This study develops a model for expected returns for a multinational firm. These returns can be divided into three parts: (1) returns of domestic investments, (2) returns of foreign investments, and (3) returns from changes in foreign exchange rates. Analysis of covariance is used to test if the beta coefficients for a group of multinational firms have changed and, if so, in which direction. Multinational firms are defined as those firms having real investments in six or more countries. Firms in the Fortune 500 Directory of Manufacturing Firms were divided into three groups: (1) Firms with six or more real investments overseas, (2) Those that had no overseas investments, and (3) Those with one to five overseas investments. Portfolio betas were then compared for the period from January, 1967 to December, 1970 to the period from January, 1973 to December, 1976 to determine if the betas changed. The former period is one under the fixed exchange rate system, and the latter period is one of floating exchange rates. The domestic firms were used to determine if changes in betas might have occurred because of changes in the overall market risk-return relationship.