Companies' Foreign Exchange Risk Management Under The New RMB Exchange Rate System

After the RMB exchange rate system reform on July 21^st, 2005, the exchange rates of RMB become more and more volatile, which enlarges the foreign exchange risk exposure of companies with foreign business. It makes the foreign exchange risk management more important to companies in China. However, companies in China did not pay enough attention to foreign exchange risk management under the former relatively fixed foreign exchange system, especially on the measurement and hedging strategy of foreign exchange risk. The main methods China's companies used to avoid foreign exchange risk are changing their operating modes, modifying the price of product, changing the date of receiving and paying foreign exchange, selecting the payment money, and so on. They can not estimate the fluctuation of foreign exchange market accurately, which leads to poor hedging of foreign exchange risk without appropriate arrangement of financial instrumentsIn order to provide theoretical support to foreign exchange risk management to companies with foreign business in China, this paper conducted systematic research in foreign exchange risk management. First, this paper points out that the trading risk to China's companies is becoming the most important after analyzing the foreign exchange market development and the trend of RMB exchange rates, and the traditional methods of avoiding foreign exchange risk by China's companies are not efficient. Secondly, this paper summarized three ways of measuring foreign exchange risk: volatility measurement, exposure measurement and VaR measurement. Among these measurements, volatility measurement is relatively more applicable and realistic. Then, this paper conducted empirical research on the volatilities of RMB against USD, EUR, JPY and HKD. Through comparisons of time series analysis on the daily yield of RMB exchange rate against USD, EUR, JPY and HKD, this paper concludes that the ARCH(1) model, GARCH(1,1) model, ARMA(2,2) model and ARCH(1) can best estimate the volatility of RMB exchange rate against USD, EUR, JPY and HKD respectively. This is of great significance to the measurement of foreign exchange risk and make the efficient foreign exchange risk management possible. Thirdly, this paper provides a foreign exchange risk control method—optimal hedging ratio method based on the previous volatility research and the development of foreign exchange market in China. The optimal hedging ratio can be calculated from minimized variance method and volatility expected from GARCH models. This hedging method is very significant to efficient foreign exchange risk management to companies in China.