Currency Risk Exposure of Chinese Corporations

Raj Aggarwal Sullivan Professor of International Business and Finance University of Akron, Akron, OH 44325 330-972-2780; aggarwa@[Link] Xiomin Cindy Chen College of Business Administration California State University, Long Beach, CA 90840 562-985-5072, xchen@[Link] Jasmin T. Yur-Austin College of Business Administration California State University, Long Beach, CA 90840

January 2011

Prepared for possible publication in Research in International Business and Finance. While the authors thank their colleagues and seminar participants for comments on earlier versions, they remain solely responsible for the contents.

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Currency Risk Exposure of Chinese Corporations Abstract In spite of the rise of China and its currency, the currency risk of Chinese firms has not been studied adequately. In this paper we document for the first time that the stock returns of Chinese firms are significantly exposed to currency risks with many firms benefiting from the rise of the Yuan. Further, the magnitudes of the currency risk coefficients for Chinese companies (<10%) are smaller than those previously documented for other countries (20%40%). However, our results also indicate that Chinese export firms are exposed to significant risk related to the ASEAN currency index. Yuan appreciation also impacts exporters to India, Australia and Russia in some industries. The results documented in this study should be of much interest to managers, scholars, and policy-makers.

1.

Introduction The Chinese economy and Chinese firms are both becoming ever more important in

the global economy and rising exports are a very important feature of the Chinese economy. In addition, in recent years, the Chinese government has once again gone to a managed float system for its currency. Chinese firms and US firms including those buying from or selling to or from China now again have to cope with a changing exchange rates. The impact of these exchange rate fluctuations that may be particularly important for Chinese firms that engage in exports and imports. Despite the growing importance of Chinese international trade, the foreign exchange exposure of Chinese companies has not been adequately investigated in the extant literature. This paper examines the foreign exchange risks faced by Chinese companies. We compute currency risks faced by Chinese firms with respect to various currencies associated with Chinas major trading partners and we explore the following questions. What is the level of currency risk exposure faced by Chinese firms overall and how does this compare to similar exposures of firms in other countries? How do the currency risk exposures of Chinese

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firms differ across industries? Do exporting firms have a higher currency risks than firms with domestic business only? This paper documents that the magnitudes of the currency risk coefficients for Chinese companies (<10%) are smaller than those previously documented for firms in other countries (20%-40%). In addition, while Chinese exporters have insignificant currency risk exposures associated with the currencies of Chinas top four trading partners, EU, US, Japan and Hong Kong, Chinese export firms are exposed to significant risk related to the ASEAN currency index. Further, Chinese exporters in three industries (agricultural/diary/fishing/hunting, textiles/apparel/footwear, and lumber/furniture/wood products) are statistically significantly adversely affected when Yuan appreciates against USD. Finally, Yuan appreciation also impacts Chinese exporters to India, Australia and Russia in industries such as construction, machinery/equipment and healthcare/pharmaceutical. Given the rising importance of Chinese international trade, these findings should be of much interest for scholars, managers, and policy-makers. The rest of the paper is organized as follows. Section 2 discusses Chinese exchange rates, exposures attributable to currency risks, the nature of currency risk management, and relevant prior studies. Section 3 describes the sample firms and methodology along with empirical results. Section 4 offers our main conclusions.

2.

Exchange rate risks and Chinese companies 2.1. Chinese exchange rates The Chinese currency Yuan was pegged to USD at 8.27 Yuan per USD from 1997 to

2005 and it was contended that Chinese exporters used to have a competitive advantage in the

global market due to the stability of the Yuan relative to US dollar. Further, as a result, the Yuans values relative to other currencies were also considered to be more predictable and manageable. This era of a fixed exchange rate changed when on July 21, 2005, the Peoples Bank of China announced that its exchange rate regime has moved into a managed floating exchange rate regime (with respect to a currency basket).1 Under the new managed floating foreign exchange regime, government intervention and market forces are combined to set exchange rates. Consequently, the Peoples Bank of China, the central bank in China, sometimes intervenes in the foreign exchange markets in an attempt to influence the price of its currency, the Yuan. For example, the bank uses its foreign currency reserves to buy Yuan to increase its value, or alternatively, it sells Yuan for foreign currency to lower its price. It has been generally contended that after this 2005 foreign exchange reform, China did not actively revalue the Yuan/USD rate and perhaps limited its rise in an attempt to help exporters overcome a decline in global demand and rising shipping costs. However, this new exchange rate policy is also guided by the need to alleviate the pressure of China's rapidly rising foreign exchange reserves. As suggested by Zheng and Yi (2007), US$ 400 billion would be an appropriate level of foreign exchange reserves for China. However, according to China Business News in 2006, China's foreign exchange reserve has been over US$700 billion by 2005. By February 2006 China had foreign exchange reserves of US$ 853 billion that have grown to over US$2.5 trillion by now; far exceeding the foreign exchange reserve held by any other country and becoming the largest foreign exchange reserve holding country.

After a period of fixed exchange rates between mid 2008 and mid 2010, the Chinese Yuan is once again in a managed float with gradual appreciation against the US dollar. While the empirical analysis in this study is based on the floating rate period beginning in 2005 (due to minimum data requirements), the general findings regarding currency exposure should also illuminate the current floating period.

Many economists have suggested that this huge accumulation of foreign exchange reserves by China is evidence of an artificially under-valued currency (Frankle and Wei, 2007). These rapidly rising trade surpluses in the face of a slowly rising Yuan imply that these changes in exchange rates have exerted only a limited influence on the competitiveness of Chinese exporting firms. In other words, Chinese firms seem to have low currency risk and the marginal appreciation of Yuan is not sufficient to modify the firms profitability and in aggregate reduce national current trade imbalances. The Chinese exchange rate policy is also driven by its need to retain its competitive advantage in labor-intensive manufacturing. Many multinational enterprises outsource their production to China because of significantly lower labor costs (Rodirk, 2006). Accordingly, Chinese companies also import cheap raw materials and export products to the global market with added value attributing to trade surplus. Outsourcing by foreign multinational enterprises is expected to be sustained in near futures despite the concerns over the potential job losses in the Western developed countries (Amiti, and Wei, 2004; Runjuan Liu and Daniel Trefler, 2008). Cheaper production costs are expected to offset any rising merchandise price due to Yuan revaluation. In addition, economists argue that China has evolved industrial innovations adopting more advanced technology into its exporting related industries. Although presumably the undervalued Yuan and low labor costs have created the China economic miracle, these factors cannot account for the entire underlying story concerning Chinas surging foreign exchange reserves. It is worth noting that, Chinese industry has gradually moved away from pure assembly to adopt newer advanced technology in its export-oriented industries. This process may have been assisted by foreign

multinationals who have played a significant role in Chinas industrial revolution. They form

joint ventures with Chinese domestic firms and operate in special economic zones in exchange for different types of subsidies (Chadee and Qiu, 2001). Regardless, China is a rapidly growing economy projected to become the worlds largest. Given the unusual

behavior of Chinese trade surpluses and exchange rates, unlike the study of currency risks in other countries, the study of currency risks for Chinese firms may be particularly interesting. 2.2. Currency risk and risk management Changes in exchange rates can potentially affect firms expected future cash flows, cost of capital, as well as firms accounting valuations. Operation hedging and financial

hedging are often employed to restrain the negative influences of currency risks (Anderson et al 2004; Walker, 2008). Financial hedging with derivatives can be implemented quickly with relatively low costs, but it is difficult to hedge against long-term, real exposure with financial contracts. On the other hand, operational hedges (such as maintaining multiple manufacturing sites, executing flexible sourcing policy, developing different business lines, diversifying markets) can hedge the economic exposure more effectively but these hedging procedures are costly, time-consuming, and not easily reversible (Aggarwal 2011). Hence, what are feasible hedging strategies for Chinese firms, especially for exportoriented firms, to mitigate potential adverse impact of such exposures? Peng, Shu and Yip (2007) report Chinese firms can engage in forward and swap transactions approved by SAFE (State Administration of Foreign Exchange). Currently, derivatives contracts of Yuan vs. five currencies (US dollar, Euro, Japanese yen, Hong Kong dollar and British pound) are available to corporate clients, among which US dollar accounts for 95% of total currency derivative contracts in the onshore market. Alternatively, Chinese firms employ offshore Yuan derivatives markets, which

comprise Yuan NDF (non-deliverable forward) concentrating in Hong Kong and Singapore or Yuan derivatives listed on CME (Chicago Mercantile Exchange) launched in August 2006. Peng et al. (2007) suggests that a liquid derivative market tends to facilitate the flexibility of exchange rates by reducing the costs of managing currency risks for firms. Given the current development of Chinese Yuan derivatives, the inclusion of more participants and an introduction of exchange-traded Yuan future contracts and options will be helpful to connect Yuan derivatives pricing in both onshore market and offshore market. Nevertheless, such derivatives are only available with sufficient liquidity for only the major currencies, limiting foreign exchange risk management by Chinese firms. 2.3. Prior studies and research questions Much prior study has been devoted to the impact of currency risks on non-Chinese firms. Many prior studies (see for example, Jorion, 1990, 1991; Bodnar and Wong, 2003; Pritamani, Shome and Singa, 2004; Zhao 2010) have employed different methodologies to investigate firms foreign exchange risk exposure. Extending these studies, non-US multinationals have also been scrutinized for their potential foreign exchange exposures to many different foreign exchange rates. For example, He and Ng (1998) measure foreign exchange exposures of 171 Japanese multinationals; Martinez-Solano (2000) examines foreign exchange exposures of 125 Spanish firms, and Aggarwal and Harper (2010) document the foreign exchange exposure of over a thousand US domestic companies. Parsely and Popper (2003) examine exchange rate exposures of public traded firms in 9 Asia-Pacific countries (Hong Kong, Indonesia, Japan, Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand), which share exchange rate arrangements or certain forms of exchange rate pegging. The foreign exchange exposures of these 9 countries are measured

against two benchmarks: Australia and New Zealand. Parsely and Popper (2003) report that many Asia-Pacific firms have larger magnitudes of foreign exchange exposures than their western industrialized counterparts. Most of firms in their study are generally sensitive to US dollar changes, followed by changes in the yen and the Euro. Unfortunately and most interestingly, while Zhao (2010) finds no stable relation between Chinese exchange rates and stock prices, there are no published studies of foreign exchange exposure of Chinese firms. Using the traditional measure of a firms currency risk as the elasticity between changes of exchanges rates and changes in a firms value (Jorion, 1990), we compute various currency risks in Chinese corporations associated with Chinas major trading partners and focus on the following questions. Do Chinese firms overall have lower currency risk

exposures than other countries? How do the currency risk exposures differ across industries? Do export firms have a higher currency risk than firms with domestic business only?

3.

Methodology, sample and results Our main motivation is to investigate the extent to which the changes in the Yuan

affect the value of Chinese firms. We set a one-year event window after the 2005 currency reform, from July 2005 to July 2006, and in addition the two semiannual sub-periods to detect patterns of either momentum or reversal due to the market overreaction or delayed reaction triggered by the shock of China implementing the reform of a new foreign exchange regime. Listed in Table 1 are Chinas top trading partners and their currencies. The foreign exchange values are quoted as Chinese Yuan per 100 units of foreign currency, the same quotation format used by the Bank of China. Table 1 details changes in each currency for two semiannual periods: July 2005 to December 2005 and January 2006 to July 2006.

[Please insert Table 1 here] The top three trading partners for China are EU, US, and Japan, comprising 42.17% of Chinas total trade (the total value of exports and imports). These top three are followed by Hong Kong and ASEAN, each comprising approximately 9%. The total Chinese trade from January to December 2006 was 17,607 billion dollars, with its top ten trading partners making up 79.67%. As shown in Table 1, currencies of these top trading partners/regions are

European Euro (EUR), American dollar (USD), Japanese yen (JPY), Hong Kong dollar (HKD), Korean won (KRW), Taiwanese dollar (TWD), Russian ruble (RUB), Australian dollar (AUD) and Indian Rupee (INR). In addition, we create a currency composite index (ASEAN index, AID) for the Association of South East Asia Nation (ASEAN), which is the 5th largest trading partner with China. This equally weighted currency index (AID) includes currencies of six major ASEAN members such as Malaysia (MYR), Philippines (PHP), Singapore (SGD), Thailand (THB), Indonesia (IDR), and Vietnam (VND). Similar to the dollar trading broad index created by the US Federal Reserve, we create a Yuan Broad Index (YBI) to capture Yuan valuation compared to the top ten trading partners with China. Weights of YBI are adjusted by trading value proportions of Chinas top ten trading partners. Also as shown in Table 1, Yuan appreciates against most currencies such as EUR (3.072%), USD (-2.533%) and JPY (-7.792%) in the first 6-month period after China reforms its foreign exchange regime. The exception is Korean Won which appreciates 0.606% relative to the Yuan. Overall, the Yuan appreciates against the ten major trading partners (YBI=2.847%). In the subsequent 6-month period, from January to July 2006, except for USD (0.943%), HKD (-1.130%), and INR (-2.967%), Yuan is actually depreciating against

currencies of the other seven major trading partners who are associated with 53.9% of Chinas total trade. Therefore, despite the widely-broadcasted Yuan appreciation against USD (USD=0.943%), as a matter of fact, six months after the foreign exchange reform, Yuan is further undervalued compared to most of its trading partners (E.U., Japan, ASEAN, Korea, Taiwan, Russia and Australia) and in these countries/regions, the price of goods made in China are up to 7% cheaper due to Yuan depreciation (e.g., EUR= 7.054%; JPY=1.981%; AID=3.878%; KRW= 6.131%; TWD=0.85%; RUB= 6.003% and AUD=0.601%). USD and HKD demonstrate similar magnitude of changes in currency value in response to Yuan appreciation as the linked exchange rate system of Hong Kong launched in 1983 pegs HKD to USD. In the second 6-month period, YBI reversely appreciates 3.208%. As discussed earlier, a firms currency risk can be measured by the elasticity between changes of exchanges rates and changes in a firms value (Jorion,1990; Bodar and Wong, 2000). Extending the arguments of a previous study (Pritamani et al. 2004), the currency risk exposure of individual firms may also be affected by the financial soundness of domestic market. For instance, while Yuan appreciation curbs the competitiveness of Chinese export, China 2006 GDP of 10.7% with the fastest growth in 11 years leads to a higher demand for goods. The inclusion of a market index return as a variable helps control for domestic macrocosmic effects. Thus the following multivariate regression is used to estimate exchange rate exposure: rit io ix rxt im rmt it where rit is the return of firm is stock in day t, rxt is the change in Yuan/foreign currency in day t, rmt is the rate of return on Shanghai Stock Exchange Composite Index (SSE Composite

Index), which represents all listed stocks (A shares and B shares) on the Shanghai Stock Exchange. The positive value of rxt indicates an appreciating foreign currency and a weakening Yuan, while the negative value of rxt indicates a depreciating foreign currency and a strengthening Yuan. Then, ix is the currency risk (i.e., foreign exchange exposure), which measures the association between changes in Yuan and stock returns of a specific firm, positive for a firm whose stock value increases (decreases) with Yuan depreciation

(appreciation) and negative for a firm whose stock value increases (decreases) with Yuan appreciation (depreciation).

Using this firm-specific time-series regression, we estimate currency risk exposure for each of the sample 837 firms listed on the Shanghai Stock Exchange (SSE). The SSE was founded on November 26th, 1990 and it is a non-profit-making membership institution directly governed by the China Securities Regulatory Commission. After 18 years of operation, the SSE has become the most preeminent stock market in China in terms of number of listed companies, number of shares listed, total market value, tradable market value, and securities turnover. Each firm is categorized based on data in their annual reports for December 2006. Accordingly, 314 firms which report foreign sales in their annual reports are defined as exporters while 523 firms without disclosed foreign sales are defined as domestic firms. Further, all of the listed companies are classified into nineteen industries as per the Chinese government system of industrial classification. real These nineteen industries are

education/arts/entertainment, transportation/warehousing,

utilities,

estate/rental/leasing,

construction,

finance/insurance,

agricultural/diary/fishing/hunting,

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wholesale/retail,

social

services,

information/communication,

electrics,

textiles/apparel/footwear, machinery/equipment, mineral/metal/steel, lumber/furniture/wood products, petroleum/plastic/chemical related, healthcare/pharmaceutical, printing/publishing, and conglomerate. Table 2 shows the average currency risk exposure of Chinese firms for the overall period as well as for the two sub-periods. As suggested by prior studies, following Yuan appreciation (foreign currency depreciation, rxt <0), stock returns of Chinese corporations are likely to decline (rit<0). Therefore, the coefficient ix is expected to be positive, especially for export firms. During the full sample period, Chinese firms display overall positive currency risk exposure associated with the changes only in AID and RUB. However, when we further examine the estimates for the two sub-periods, it shows that, for many currencies the ix reversed signs between the two sub-periods that a positive effect in the first sub-period is often offset by a negative effect in the second sub-period. In the first period Chinese firms report positive currency risk exposure to changes in USD, JPY, HKD, AID, RUB and AUD while in the second period the positive currency risk exposures are relative to AID, KRW, TWD, RUB and INR. The positive currency risk exposure estimates support the theoretical hypothesis that following Yuan appreciation, stock returns of Chinese corporations decline. However, it is noticeable that for many Chinese corporations, their stock returns surprisingly increase after Yuan appreciation. For example, as reported in Table 2, stock returns of 396 Chinese firms decrease but stock returns of 420 Chinese firms go up after USD depreciation relative to Yuan. It indicates that Yuan appreciation didnt hurt the competitiveness of many Chinese firms in the world market and instead Yuan appreciation translates into higher returns in these

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firms. After Yuan appreciation, if products are in great demand and the units sold are less sensitive to the rising dollar price, then the total sales in term of dollars are higher than before. Given the same operating expenses, a higher profit is possible and then further translated to growing earnings and higher firm values. Meanwhile, the magnitudes of our reported exposures are much smaller than those documented in prior studies for firms in other countries. He and Ng (1998) reports that the median of currency risk exposure for 171 Japanese multinationals is 24.2%. Martinze-Solano (2000) finds that the average currency risk exposure for Spanish firms is 11.06% and Pritamani et al. (2004) reports currency risk exposure of 10% to 30% for US firms. These studies use the same firm-specific time-series regression model to estimate corporate currency risk as we do in this study. However, we cannot compare our results with studies such as Pantzalis et al (1999) and Carter et al (2001), which estimate currency risk using different methodologies. Our results indicate that the currency risk impact of the appreciation of the Yuan on Chinese firms is not as great as that in other countries on average. Shown in Table 2, from July to December 2005, the estimated coefficient ix ranges from 0% to 10% (e.g., EUR=0.0054, USD=0.0527, JPY=0.0003, HKD=0.0364, AID=0.0461, KRW=-0.0897,

RUB=0.0576, and AUD=0.0673 ) with two exceptions of TWD (-0.2934) and INR(-0.1187). From January to July 2006 (more than six months after the Yuan re-valuation reform), the ix coefficients of USD, JPY, HKD, and AUD reverse to negative signs, implying Chinese stock value increases (decreases) with Yuan appreciation (depreciation) relative to these currencies. While the ix coefficients of KRW and INR change from negative to positive, implying

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Chinese stock value decreases (increases) with Yuan appreciation (depreciation) relative to these two currencies. [Please insert Table 2 here] The economic globalization that began in the nineteen eighties is increasingly influencing the Chinese economy also. Facing increased integration of financial and product markets, domestic Chinese firms may be increasingly exposed to currency risks perhaps through interest rate differentials and through product markets. As international trade

continues to expand for China, domestic firms may also face currency risks as their competitors, suppliers, and customers increasingly engage in cross-border transactions. As a result, a pure domestic business may not exist soon in China. This is especially likely to be true in an export-oriented economy like China. Consequently, in the future there may be no differential in impacts of exchange rate changes between exporters and domestic firms. Indeed, consistent with the results documented in Aggarwal and Harper (2010) for the US, as reported in Table 2 for Chinese firms, we already do not see much difference in the currency risk exposures of exporters or domestic firms. Exporters have exhibited positive relationship between their stock returns with changes in the exchange rates of AID, RUB and INR, while domestic firms display positive currency risk exposure for RUB only. For both exporters and domestic firms, their stock returns increase when Yuan appreciates against currencies of Chinas top four trading partners such as EU, US, Japan and Hong Kong. Plausible explanations include the possible use of hedging techniques by Chinese firms and that China has moved to producing higher-income consumer electronic products over time (Rodrik, 2006) that are less affected by changing exchange rates.

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However, consumers in the ASEAN countries, Russia, and India seemed more price sensitive, as shown in Table 2, stock returns of Chinese exporters are positively related to the changes in the exchange rates of AID, RUB and INR. When Chinese Yuan appreciated to these currencies (AID, RUB and INR depreciated), stock returns dropped in these Chinese export firms, implying possible declining exports. Bondar and Gentry (1993) document that 9 out of 39 US industries and 5 out of 20 Japanese industries experience significant foreign exchange exposures from 1979 to 1988. In addition, He and Ng (1998) show Japanese multinational firms in three industries (electric, machinery/ precision equipment and transport equipment) have larger exchange rate exposures than their counterparts in other industries. According to the Ministry of

Commerce, Chinas major exported products include machinery & electrics, textiles, apparel & footwear, minerals & steel, agricultural products, furniture, plastic products, and other chemical related products. Table 3 presents the average of currency risk exposure of firms in 19 industries in response to changes of USD. The firm-specific time-series regressions are estimated to find out ix of each firm. Subsequently, the average of all firms' ix in each industry is calculated to represent industrial average currency risk exposure. The findings suggest that 11 industries are positively affected when Yuan appreciates against USD (that is, have negative currency risk exposure), while 8 industries are adversely affected (that is, have positive currency risk exposure), Among the 8 industries, the positive currency risk exposures ( ix) are statistically significant for three industries (agricultural/diary/fishing/hunting, textiles/apparel/footwear, and lumber/furniture/wood products). We also examine the industrial distributions of

currency risk related to other currencies (not reported in tables, but available upon request).

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For example, we find that Yuan appreciations from 2005 to 2006 tend to reduce Chinese export to Russia in the construction, transportation/warehousing, machinery/equipment, and healthcare/pharmaceutical industries. [Please insert Table 3 here] Next, we use two-way analysis of variance (ANOVA) to re-test whether currency risks significantly differ across industries and whether the currency risk exposures of export firms significantly differ from those of domestic firms. Finally, we would like to address the issue of how currency risks are influenced by the industrial classification of export firms by using an interaction variable (export firms with their industrial classifications). These ANOVA tests are reported in Table 4. As shown in Table 4, industry classifications display significant currency risk exposures in response to changes in EUR (p=0.0072), JPY (p=0.0135), ASEAN (p=0.0097), RUB (p=0.0327) and AUD (p=0.0614), while export firms, regardless their industrial classifications, reveal significant currency risk associated with INR (p=0.0489). Table 4 also indicates that export firms within certain industries are more sensitive to changes in foreign exchange rates RUB (p=0.0610), AUD (p=0.0695) and INR (p=0.0118). Thus, we take ANOVA tests to examine the industrial distributions of currency risk related to RUB, AUD and INR, separately (not reported in tables, but available upon request). we find that Yuan appreciation seems to adversely affect Chinese firms that export to India, Australia and Russia in industries such as construction, machinery/equipment and

healthcare/pharmaceutical. [Please insert Table 4 here] While this study has made a significant contribution to our understanding of the exchange rate exposures of Chinese firms, it has just explored the surface of an important

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topic. There is much future research in this area that would be useful. For example, given the notion of the accelerating Yuan appreciation in the future, a larger magnitude of currency risk exposure may be found in a future study period. Furthermore, a survey of currency risk management may be undertaken, which may be of great value to managers. Nevertheless, given the rising importance of China, its economy, and its exports, the results documented in this study should be of much interest to managers, scholars, and policy-makers.

4.

Conclusions In July 2005, following the abandoning of the Chinese policy of fixing the exchange

rate of the Yuan versus the US dollar, the Yuan appreciated 2.1% against US dollar. The Chinese Yuan went on to appreciate further against the US dollar the following year before it was later again fixed in relation to the US dollar. The floating rate period was a significant policy change by the Chinese government and Chinese firms had to learn to cope with fluctuating exchange rates. In spite of the growing international importance of the Chinese economy and of Chinese firms, there is no prior study of the currency risks faced by Chinese firms. This paper investigates whether Chinese firms' daily stock returns are sensitive to changes in the foreign exchange values of the Yuan for Chinas top ten trading partners and the foreign exchange exposures of Chinese exporters and of firms classified by industry. We document that the stock returns of Chinese firms are significantly exposed to currency risks. For some firms, their value declines when the Yuan appreciates but for many Chinese corporations their stock returns instead increase. These results indicate that the Yuan appreciation did not hurt the competitiveness of many Chinese firms in the world market and instead the Yuan appreciation translates into higher returns in most Chinese firms. For

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example, while the stock values of 396 firms decline with Yuan appreciation, stock values increase for 420 firms and firms in 8 industries are adversely affected when Yuan appreciates against the USD, 11 industries are positively affected. Further, the magnitudes of the currency risk coefficients for Chinese companies (<10%) are smaller than those previously documented for other countries (20%-40%). Overall, we find that Chinese exporters have insignificant currency risk exposures associated with the currencies of Chinas top four trading partners: EU, US, Japan and Hong Kong. However, our results also indicate that Chinese export firms are exposed to significant risk related to the ASEAN currency index. Yuan appreciation also impacts exporters to India, Australia and Russia in industries such as construction, machinery/equipment and healthcare/pharmaceutical. Based on the experience of other countries such as Japan, the average currency risk exposure of Chinese corporations of less than 10% in the early period of Yuan appreciation in our study is likely to increase significantly as the Yuan appreciates at an increasing rate in the future (Yuan reached a new high of 7.025/$ on March 26, 2008, rising 17.84% in value since the 2005 Chinese foreign exchange reform). While this study has made a significant

contribution to our understanding of the exchange rate exposures of Chinese firms, it has just explored the surface of an important topic. There is much future research in this area that would be useful. Nevertheless, given the rising importance of China, its economy, and its exports, the results documented in this study should be of much interest to managers, scholars, and policy-makers.

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