Variability in foreign exchange (FX) rate has been one of the major economic and financial factors affecting cash flows and common stocks value. After the collapse of post-war Bretton Woods fixed exchange rates in the 1970’s, the relative prices of currencies began to fluctuate. The rapid expansion in international trade and adoption of floating exchange rate regimes by many countries led to increase exchange rate volatility.

As economic integration and globalization have been increasing year by year, exchange rate movements have become very important source of risk for financial firms as well as non-financial firms. In this context, it is very important to mention that virtually all existing empirical studies estimate currency exchange rate exposures on the basis of share prices. However, the assessment of cash flow and stock price exposures which will be studied in this research will represent a rational alternative to the analysis of stock price exposures. In fact, it is the impact of exchange rate risk on corporate cash flows rather than equity prices per se, that is emphasized in the theoretical literature on corporate risk management, either for tax reasons, managerial performance, bankruptcy, investment decisions or compensation purposes.

Jacque (1996) points out that change in a company’s earnings due to unexpected foreign currency exchange rate changes relatively to their domestic currency is considered as foreign exchange rate risks. Changes in exchange rates may affect firms’ profitability and value. Exchange rate changes can also impact on the level of competitiveness of the firms which are exposed to exchange rate risk, or affect the value of their net assets denominated in foreign currencies.

Adler and Dumas (1984) show that even firms whose entire operations are domestic may have affects of exchange rates of foreign currencies, if their output and input prices are influenced by currency movements.

Moreover, Eiteman et al. (2006) says that in general, firms are exposed to three types of foreign exchange risk: translation exposure, transaction exposure and economic exposure. In practice, economic exposure is computed as the net sensitivity of some aggregate measure of firm value to currency fluctuations. Economic exposure contains of the direct and indirect effects of currency fluctuations by focusing on the net sensitivity. In practice, there is little general agreement on the use of appropriate choice of ‘‘aggregate” measure. In this research project it is focused on the impact of economic exposure of Malaysian non-financial firms (from consumer products industry) on their values. Corporate managers will also be interested in the exposures of corporate cash flow measures such as sales, operating cash flow and earnings for reasons of corporate planning and risk management.

Problem statement

As economic integration and globalization have been increasing year by year, exchange rate movements have become very important source of risk for financial firms as well as non-financial firms.

Also, the internationalization of capital markets has resulted in inflow of vast sums of funds between countries and in the cross listing of equities. This has therefore made investors and firms more interested in the volatility of exchange rate and its effect on stock price and stock market volatility. According to Yucel and Kurt (2003), floating exchange rate appreciation reduces the competitiveness of export markets; and has a negative effect on share prices as well as the domestic stock market. On the other hand, for import dominated country, it may have positive effect on the stock market by lowering input costs.

Malaysia presents an example of an open economy which engages in international trade with several countries and hence susceptible to foreign exchange rate volatility.

However, empirical evidence on the influence of foreign exchange market volatility on stock market is largely inconsistent. These have been in the contest of developed economies. Mishra (2004) found no theoretical consensus on the interaction between stock prices and exchange rate. However, Solnik (2000) argues that there is a negative correlation between stock market and local currency.

The openness of a country’s economy is recognized as a cause of volatility of its market. Malaysia presents a classic example of an open economy which engages in international trade transaction. Moreover, with advert of globalization, developing economies are becoming more integrated into developed economies as the results of increasing flow of imports and exports. Malaysia is not an exception. A cursory examination of foreign exchange rate history in Malaysia shows some considerable level of volatility. Therefore, it would be interesting to explore the effect of its foreign exchange volatility on cash flows as well as stock prices of its non-financial companies. Again, much work on the effect of the exchange rate volatility in the developing country like Malaysia has not been done. Thus, for that reason the study intended look at the effect of foreign exchange exposure on non-financial companies’ cash flows and stock prices in Malaysia.

Research objectives

Objective of the current research is to determine whether cash flows and stock prices of companies from consumer products industry are affected by exchange rate exposure. This research project attempts to assess the economic exposures of the firms chosen from the Bursa Malaysia Main market. The issues are important for investors as well as corporate risk management. The research aims to find answers to the following questions:

• Are cash flows of the companies exposed to exchange rate risk?
• Are stock prices of the companies exposed to exchange rate risk?
• Which currencies have major influence on the companies’ cash flows?
• Which currencies have major influence on the companies’ stock prices?

Literature review

It is also noticeable whether the firms’ cash flows are sensitive to exchange rate movements. Perhaps we should also point out the fact that Grambovas and McLeay (2006) are convinced that empirical analysis confirm that currency fluctuations may affect firm values, especially with consideration to the influence of foreign exchange rate movements on the firms’ cash flows and their accounting earnings, and on their stock prices.

Martin and Mauer suggest that economic exposure, which typically has a longer-term time dimension, encompasses the competitive and indirect effects of exchange rate risk. Many academics such as Hodder (1982), Marston (2001) Pringle (1995), Shapiro (1975) and von Ungern-Sternberg & von Weizsacker (1990) argue that unlike transaction exposure, economic exposure can affect even domestic firms. Economic exposure arises from changes in the sales prices and volumes, and the cost of inputs of the firm and its competitors as a result of exchange rate changes. Miller & Reuer (1998) and Sundaram & Black (1992) argued that geographically positioning production, sales, sourcing, and financing operations is effective for reducing economic ex