Ascertaining the level of exposure was very important in determining the success or failure of a business. Therefore, exposure management was regarded as one of the most important corporate functions (Sprcic & Sevic, 2012). Bartram and Bodnar (2007) noted that firms with insignificant observed exchange rate exposure were likely to have effectively managed their exposure level. Hence, comparatively lower currency exposure in advance market was due to the existence of numerous strategies and tools in the market to alleviate the impact of exposure. Financial hedging involved the use of financial derivative as an investment tool to hedge and mitigate currency exposure. In other words, derivatives protected any transaction from unexpected currency movement. In fact, financial derivative had become a standard tool to hedge exchange rate related risk (Dӧhring, 2008).
Hedging increased firm value by reducing claims to firms’ cash flows (Smith &
Stulz, 1985). Lower external claims provided smoother cash flows for the firms with lesser uncertainties. In addition to the exposure mitigating benefit, hedging derivative also held the potential to enhance firm value by reducing expected tax liabilities (Smith
& Stulz, 1985). The tax benefit was acquirable if the cost of hedging did not exceed the potential lost incurred should the hedging was not in place. Under this condition, the
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expected post-tax firm value would increase in response to the lower variability of pre- tax firm value due to hedging (Sprcic & Sevic, 2012).
Clark and Judge (2008) highlighted the importance to differentiate hedging strategies employed by the sample firms before conducting the analysis. The study only included both unhedged and hedged firms. From the sample, 25% of the hedged firms solely hedged their exposure using currency derivatives, while 66.67% used foreign currency debt and 33.33% were non-hedger. Mixed effect of hedging was found with respect to financial distress for the overall foreign currency hedging.
However, the effect of financial distress became significant when the analysis focused on the derivative hedgers.
Meanwhile, Allayannis and Ofek (2001) claimed that extensive use of foreign currency derivatives and other hedging instruments resulted in insignificant effect of exposure on firm values. Similar notions were also found by Parsley and Popper (2006) as the results of varying exposure behaviour for each country under their study.
Similarly, firm-level study by Ameer (2010) attributed the variation of the firm-level hedging behaviour to firms’ specific structure. The study asserted the risk-averse nature of the Malaysian sample firms which prompted their failure to benefit from the derivative market. Their study on 378 S&P 500 nonfinancial firms in the US showed currency derivative hedging managed to reduce the amount of currency exposure faced by the firms.
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A closer look on the Malaysian market showed the minimal use of foreign currency futures and options in Bursa Malaysia derivatives market (Chong et al., 2014).
Henceforth, Malaysian companies tended to use options and forward contracts in the over-the-counter (OTC) market. Accordingly, the foreign currency hedging market in Malaysia was heavily dominated by the OTC products. Forward contracts were the most popular type of derivative contract for Malaysian multinationals. The mean of the total volume of derivative contracts was 92.43%. The results showed that Malaysian multinationals preferred to use foreign currency forward contracts for hedging foreign currency risk. Similarly, Ameer (2009, 2010), Othman and Ameer (2009), and Chong et al. (2014) found that customisable and flexible forward contracts were quite popular in Malaysia.
Figure 2.5 illustrates the distribution of over-the-counter foreign exchange turnover according to the respective instruments in Malaysia from 2010 to 2019. Spot transaction was the mostly used instrument which involved an agreement between two parties to buy one currency against selling another currency at an agreed price for settlement on the spot date.
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Source: Triennial Central Bank Survey by the Bank of International Settlement Figure 2.5: Over-the-counter Foreign Exchange Turnover by Instruments in
Malaysia, 2013 to 2019.
The second mostly used instrument was the foreign currency swap involving the agreement to exchange currency between two foreign parties. The third instrument was the outright forward transaction that involved locking the exchange rate and a delivery date beyond the spot value date. The least used instruments were currency swaps and options.
0 5000 10000 15000 20000 25000 30000 35000
2013 2016 2019
Daily average in million of the US dollar
Over-the-counter Foreign Exchange Turnover by Instruments in Malaysia, 2013 - 2019
Spot Transaction Otright Forwards FX Swaps Currency Swaps Options
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Source: Triennial Central Bank Survey by the Bank of International Settlement Figure 2.6: Over-the-counter Foreign Exchange Turnover by Instruments in Malaysia,
the UK and the US, 2013 to 2019.
Apart from to the use of derivative in Malaysian market, Figure 2.6 provides an overview of the derivative use of the UK and the US markets. The comparison is meant to support the postulate that Malaysian derivative market is relatively very small compared to the overall use in the US and the UK market. In 2013, the total average turnover of OTC foreign currency exchange in Malaysia was USD11,095 million which denoted less than 1% of the volume in the UK market (USD 1262799 million) as the biggest financial market. The volume for the US was USD2,725,993 million in 2013.
Malaysia and the US markets suffered a plunge in 2016, while the UK market slightly increased. Despite the fluctuations throughout the years, Malaysia remained as the smallest market in the comparison.
0 500000 1000000 1500000 2000000 2500000 3000000 3500000 4000000
2013 2016 2019 2013 2016 2019 2013 2016 2019
Malaysia UK US
Daily average in million of the US dollar
Over-the-counter Foreign Exchange Turnover by Instruments, 2013 - 2019
Spot Transaction Outright Forwards FX Swaps Currency Swaps Options
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