The association of Exchange rates and Stock returns : Linear Regression analysis

Abstract: The association of exchange rates with stock returns and performance in major trading markets is widely accepted. The world’s economy has seen unprecedented growth of interdependent; as such the magnitude of the effect of exchange rates on returns will be even stronger. Since the author perceives the importance of exchange rates on stock returns, the author found it interesting to study the effect of exchange rates on some stocks traded on the Stock exchange. There has been a renewed interest to investigate the relationship between returns and exchange rates as such; the author has chosen to investigate the present study to focus in the United Kingdom with data from the London Stock exchange .The author carried out his research on 18 companies traded on the London Stock Exchange in the process, using linear regression analysis. Taking into account the fact that the magnitude of exchange rate movements on stock returns is governed by a series of factors, the author did set up a selection criteria which spread across a series of industries ranging from financial services, manufacturing, aviation, mining, tobacco, fashion and food processing. All selected companies are of the FTSE 100 companies. The author produced results that to some degree are consistent with predictions in the theoretical framework. The author find significant exposure of stock returns to changes in exchange rates for some companies in the sample of FTSE 100 firms used in the study. The author equally finds out that particular currencies may be of more risk to certain companies than to others by introducing euro values in to his regression equation. This gives the compelling evidence that these companies rely heavily on external sales and revenue. The author, further employed lagged values of exchange rates in to his regression and found significant evidence of the possibility of mispricing for certain stocks and the impact of the previous days trading figures on present stock prices. The author believes that the weak responds in certain cases was as a result of hedging strategies put in place by these companies and risk management strategies which tend to minimise the effect of exchange rates movements.