Management of exchange rate risk in Icelandic corporations

Abstract

We survey Icelandic corporations on their exposure to foreign exchange risk, how they manage that risk and the corporate governance framework they adhere to. The survey was sent to 181 of the country’s largest corporations. We received 69 responses, or 38%, and of these 57, or 82.5%, are exposed to foreign exchange risk. One of the main findings is that for the firms that face material foreign currency risk, a 10% weakening of the home currency changes the value of the firm on average by 4.9%. Risk management mitigates that risk, reportedly, on average to 2.7%, or by almost half. The corporations are mostly exposed to foreign exchange risk through income, expenses and cash flow. Those corporations who have the Icelandic krona as home currency are also exposed to foreign currency risk through their liabilities. About two out of three of the firms have a formal foreign exchange risk management policy, and about a third of these policies are formally approved by the board. However, less than half have a defined risk appetite for foreign exchange risk exposure. The implementation of risk management is quite centralized within the sample, and centralization increases with the size of the corporation. Chief financial officers are usually responsible for foreign currency risk management, but in smaller firms it is often the executive of the firm, while a few large firms have a separate chief risk manager who is responsible. The main objective of foreign exchange risk management is most frequently to reduce variability in cash flow or profit or to ensure that cash flow remains above a certain minimum. Operational hedges are used more actively to obtain these objectives than financial hedges, with more than 95% of firms saying they use operational hedges compared to 76% who use financial hedges. Purchases in foreign currency are most commonly used as operational hedges, while financial hedging is mostly conducted by borrowing in foreign currency or with derivative contracts, which is each used by about half of the firms.