Foreign Currency Derivatives is an Effective Tool for Hedging Foreign Exchange Rate Exposure

This study is an earnest attempt to examine the foreign exchange exposure of Indian nonfinancial firms and its FX exposure management by using foreign currency derivatives, after the ICAI's guidelines regarding reporting system of off-balance sheet financial instruments for risk management in 2005. A sample of 96 Indian non financial firms are examined by this study for a period from 2006 to 2012. A two stage cross sectional regression frame work is used to test the main hypothesis of foreign exchange rate exposure that can be effectively hedged by foreign currency derivatives.

The study has found a statistically significant negative relation between foreign exchange exposure and use of foreign currency derivatives. It evidencing that the use of financial instrument is effective hedging tools for reducing currency exposure. The study found statistically significant evidence for supporting the hypothesis as found in the line of earlier literature.