Interest and foreign exchange management among UK
1- INTRODUCTION One of the main purposes of annual reports is to provide information that is useful to their users (Day, 1986). Many authors have dealt with the issue of clarity and understandability of the annual reports (Lee and Tweedie, 1975; Smith, 1992; Keane, 1977). In fact many authors emphasized the fact that shareholders tend to read the narrative part of the annual report which normally includes good news, rather than reading statutory part and usually investors make their investment decisions depending on those good news (Tauringana and Chong, 2004; Smith and Taffler, 1992).
However In order to make an informed investment decision, an investor who is contemplating investment needs to understand both the potential rewards and the associated risks (IOSCO, 1995). The main aim of this paper is to summarize what has been written so far about what UK multinationals corporations are doing in order to manage Financial Risk specifically Interest & Foreign Exchange Risk Management and to propose a methodological approach in order to conduct a research concerning this issue.
2- LITERATURE REVIEW
With the changing business environment and increased awareness of the shareholders and investors the information needs for assessing risk has also been changed. Risk assessment plays an important role in the decision making of the investors. Researchers and business bodies have increased their concentration on the area of risk analysis and disclosure in order to respond to the needs of the shareholders and investors. In this section we will take a look at the literature of the research been undertaken in the area of risk disclosure and analysis.
Smith (1999) defines risk as a decision expressed by a range or possible outcomes with attached probabilities. When there is a range of possible outcomes but no assumed probabilities, there is only uncertainty (ibid. ). Hertz & Thomas (1984) have suggested that “. Risk means uncertainty and the results of uncertainty… risk refers to a lack of predictability about problem structure, outcomes or consequences in a decision or planning situation. ”
In a ISO/TMB Risk Management Terminology Paper (1999) risk is defined as combination of the probability of an event and its negative or positive consequences,” In (Report to NASD Regulation, 1997) respondents of survey defined risk as the chance of: 1) losing some of their original investment; 2) the value of a fund not keeping pace with inflation; 3) fluctuations in the value of a fund; 4) not having sufficient wealth at the end of an investment horizon to achieve financial goals;
5) decreases in the income distributed by a fund; 6) the performance of a fund falling short of that of bank certificates of deposit; 7) a fund under performing an index; and 8) sustaining losses within the first year of an investment. Risk thus is essential to an enterprise, because it is inherent in the pursuit of opportunities to earn return for its owners. It follows that in order to understand properly the potential for the future performance of any company; investors need a proper understanding of the risks it undertakes. This will be based on the following information (ICAEW, 2002): 1.
An analysis of the risks affecting the company’s business 2. What measures are applied in quantifying these risks? 3. What actions the company takes in order to manage the risks to which it is exposed. Describing the risk associated with a particular investment product is usually complex. Also, investors have different investment objectives and different appetites for risk, as well as different abilities in understanding risk.
Therefore, it is difficult to draw general guidelines for disclosure that take into account all these factors (IOSCO, 1995). Here are three types of exchange rate risk exposure, which a company has to face: • Translation exposure • Translations exposure • Economic exposure.
The first, translation exposure, is the change in accounting income and balance sheet statements caused by changes in exchange rates. Translation exposure has to do with setting a particular translation, like a credit sale, at one exchange rate when the obligation was originally recorded at another. Finally, economic exposure involves changes in expected future cash flows, and hence economic value, caused by a change in exchange rate (Van Horne & Wachowicz, 2001).
3- REASONS FOR CHOOSING THIS TOPIC The fundamental reason for choosing this topic is that having searched literature I found that very few works have been conducted concerning firms’ management of interest rate and foreign exchange risk.
This fact has encouraged me to do this piece of work in order to contribute to the existing knowledge about this subject by adding a new point of view. Another reason is that most investors are people with poor background in accountancy, so it is so difficult for them to understand contents of annual reports. In addition to that investors should understand the relationship between risk and return, so that investors evaluating a company’s performance do not focus solely on return, but also on the risk assumed to produce the return. This has urged me to conduct this study in order to show the importance of management of interest rate and foreign exchange risk for the companies. 4- AIM.
The aim of this research is to examine if the UK firms are successfully undertaking management of interest rate and foreign exchange risk. 5- OBJECTIVES ? To review the literature about this issue up till now. ? To improve the presentation of risk factors. ? Ensure that companies adequately address the risks of interest rate and foreign exchange rate. ? To help investors assess whether a company’s potential return is an adequate reward for the risks taken. ? Provide an investor with sufficient information about the risk of investing in a company to evaluate whether this company is an appropriate investment vehicle to meet the investor’s personal needs within the available investment time horizon.