Financial Corporations In Africa And Risk Management

Africa and Risk Control 1

MANAGEMENT OF FOREIGN EXCHANGE AND INTEREST RATE RISK IN THE

AFRICAN FINANCIAL INDUSTRY

By (Name)

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Instructor

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Africa and Risk Control 2

ABSTRACT

There exist various strategies that are considered to be effective in the management of foreign

exchange risk and interest rate risk. Each of these strategies, however, gets established based on

certain assumptions, for a particular risk profile. It gets often considered that a lot of techniques

get applied to a given situation. The rising query as to which approach would get deemed to gain

the best outcome within a given scenario. The present research handles this question empirically

by analyzing the derivatives African corporations use in mitigating financial risks. The risks

strategies of management considered for this research consisted of forwards, options contacts,

and swaps. The study makes an analysis and evaluation of these strategies to find out how

African corporations manage their interest rate and foreign exchange risk exposure using the

derivatives. Besides, the study also investigated the impact of FERM and IRRM on the

performance of African financial organizations. Most African corporations get faced with several

teething problems. These problems stem up from the kind of targeted customers as well as the

impeded operation system. Most of the tools used in hedging currency risks are either available

but get traded in inefficient or illiquid markets or, are not available in developing markets. This

challenge makes the range of goods available exceedingly constrained. This limitation has put an

additional burden on corporate managers and treasurers to explore an effective hedge to their

exposures in the exotic economy. The research aimed to establish how the financial industry in

Africa can handle foreign exchange tariffs and interest tariffs risks. The study considered a

descriptive research design. The population target consisted of 20 corporations across Africa.

The research applied a sampling approach to picking all the 20 commercial corporations due to

the large population. The study used secondary data. Again, the application of multiple linear

regression got used in examining the degree of impact of the independent variables on dependent

variables.

Keywords: cross-currency hedge, foreign exchange risk management (FERM), interest rate risk

management (IRRM), risk management strategies

Africa and Risk Control 3

TABLE OF CONTENTS

ABSTRACT ...................................................................................................................................................... 2

ABBREVIATIONS ............................................................................................................................................ 5

CHAPTER ONE ............................................................................................................................................... 6

1.0 INTRODUCTION ....................................................................................................................................... 6

1.1 Research Background and Motivation ................................................................................................ 6

1.2 Research Problem ............................................................................................................................... 7

1.3 Objectives............................................................................................................................................ 7

1.3.1 The general Objectives ................................................................................................................. 7

1.3.2 Specific Objectives ....................................................................................................................... 7

1.4 Significance of the Study ..................................................................................................................... 7

1.5 Methodology Outline .......................................................................................................................... 8

1.6 Overview ............................................................................................................................................. 8

CHAPTER TWO .............................................................................................................................................. 8

2.0 LITERATURE REVIEW ............................................................................................................................... 8

2.1 Introduction ........................................................................................................................................ 8

2.2 Theoretical Review .............................................................................................................................. 8

2.2.1 The Theory of Foreign Exposure .................................................................................................. 9

2.2.2 Interest Rate Parity Theory .......................................................................................................... 9

2.2.3 Theory of International Fisher Effect (IFE) ................................................................................... 9

2.2.4 Purchasing Power Parity (PPP) ................................................................................................... 10

2.3 Indicators of Financial Performance of Corporations ....................................................................... 10

2.3.1 Internal Factors Affecting Corporations..................................................................................... 11

2.3.1.1 The Availability of Capital ................................................................................................... 11

2.3.1.2 Quality of Assets ................................................................................................................. 11

2.3.1.3 Efficiency of Management .................................................................................................. 11

2.3.2 Macroeconomic Factors ............................................................................................................. 11

2.4 Empirical Review ............................................................................................................................... 11

2.5 Risk Management Strategies ............................................................................................................ 13

2.5.1 Forward Contracts...................................................................................................................... 13

Africa and Risk Control 4

2.5.2 Cross- Currency Swaps ............................................................................................................... 13

2.5.3 Options ....................................................................................................................................... 13

2.5.4 Leading and Lagging ................................................................................................................... 13

2.5.5 Price Adjustments ...................................................................................................................... 13

2.6 Foreign Exchange Risk Management (FERM) ................................................................................... 13

2.7 Interest Rate Risk Management........................................................................................................ 14

2.8 Financial Derivatives and Risk Mismanagement in the African Financial Industry ........................... 16

2.9 Summary of the Chapter ................................................................................................................... 16

CHAPTER THREE .......................................................................................................................................... 17

3.0 RESEARCH METHODOLOGY .................................................................................................................. 17

3.1 Introduction ...................................................................................................................................... 17

3.2 Research Design ................................................................................................................................ 18

3.3 Sample Design ................................................................................................................................... 18

3.4 Target Population.............................................................................................................................. 19

3.5 Research Methods ............................................................................................................................ 19

3.6 Data Collection .................................................................................................................................. 20

3.6.1 Data Collection Procedure ......................................................................................................... 20

3.7 Data Analysis ..................................................................................................................................... 21

3.7.1 Analytical Model ........................................................................................................................ 21

3.8 Diagnostics Tests ............................................................................................................................... 23

3.8.1 Normality ................................................................................................................................... 23

3.8.2 Multicollinearity ......................................................................................................................... 23

3.8.3 Heteroscedasticity ..................................................................................................................... 23

3.8.4 Autocorrelation .......................................................................................................................... 23

3.8.5 Stationarity Tests ....................................................................................................................... 24

3.9 Ethical Consideration ........................................................................................................................ 24

Africa and Risk Control 5

ABBREVIATIONS

ROA: Return on Assets

FRM: Financial Risk Management

IFE: International Fisher Effect

PPP: Purchasing Power Parity

SPSS: Statistical Package for the Social Sciences

FERM: Foreign Exchange Risk Management

IRRM: Interest Rate Risk Management

ANOVA: Analysis of Variance

Africa and Risk Control 6

Management of Foreign Exchange and Interest Rate Risk in the African Financial Industry

CHAPTER ONE

1.0 INTRODUCTION

1.1 Research Background and Motivation

Interest rate and foreign exchange risk involve an integral part of a business that requires

a proper understanding of the corporation needs as well as the trading activities in the financial

market exposures. Corporations such as banks operate using foreign currencies and get

inevitably open to the risk of foreign exchange. Interest rate risk might unfavorably influence the

financial condition of a business, and any changes can affect both the current earnings and the

future earnings of the company (Osuoha, Samy and Osuoha 2015, p.19). The changes involved

in the rate of interest can also influence the economic value of a business's capital, reflecting on

the changes in an institution's value of financial instruments. Therefore, the management of these

risks is essential to the stability of any corporation.

Most African markets get characterised by rising volatility in the rates of foreign

exchange and rates of interest for prices of commodities and securities. Subsequently, these firms

are likely to get exposed to financial risks. The presence of various derivatives may be essential

in contributing to the practical management of financial risk by corporations and may exhibit a

constructive effect on the firm's price through proper handling of interest tariff exposure and

proper approach to international trade challenges within the financial service business (Deng,

Elyasiani and Mao 2017, p.115). According to Bartram (2017), the reasons for management of

risks include the agency cost and financial distress reduction, realising the cost advantages at the

corporation level and differing tax of external financing.

Volatility increase earnings and cash flows may result in rising in the fiscal distress costs.

Moreover, derivatives use can get productive when the cash flows and earnings volatility get

reduced. A rise in volatility in rates of currency and interest rates get matched by a significant

improvement in the utilisation of risk management strategies such as forward contracts, cross-

currency swaps, options, leading and lagging as well as adjustment of prices (Chance and Brooks

2015). Managers currently have a variety of derivatives instruments present in managing

organisation openings to volatility in interest rates and foreign exchange rates. Deng, Elyasiani,

and Mao (2017) reported that the estimated value of derivatives used within four years from

December 2008 to December 2012 rose from USD 600 trillion from USD 632 trillion

worldwide.

The risk management and the use of derivatives account for a significant portion in the

corporate sector, for example, 92 per cent of the 500 largest companies in the world use

derivatives in the management of interest rate risks and 85 per cent of the corporations use

derivatives in management of currency risks (Butler 2016). Derivatives markets may enhance

finance risk exposure management because they permit shareholders to transfer and unbundle

financial risk. The derivatives expansion market among African nations would allow self-

insurance of companies against the volatile flow of capital and hence, reduction in their reliance

on financing from banks. Moreover, the financial management risk by business treasurers gets

gradually significant part of alarm for African firms.

This dissertation argues that the rate of foreign exchange and interest risk management

are integral parts of every corporation's decision on foreign currency exposure. Therefore, it has

far mainly focused on the establishment of the relationship between financial derivatives and risk

mismanagement in the African financial industry through examining of how some corporations

Africa and Risk Control 7

in Africa handle their interest tariff exposure and international trade challenges using derivatives

in the financing service business

1.2 Research Problem

The risk hedging of foreign exchange requires to get tailored around an institution’s

mission and vision reports, risk appetite, operational infrastructure as well as risk exposure. As a

result, the corporations get abound with risk management. According to Griffith-Jones (2016),

both the domestic and international companies face risks and should ensure that the interest rate

and currency risks get adequately managed. The constant changes in the aggressive and fiscal

setting of most corporations are designed to aid the management in controlling risk and hence

limit the outcome of indecisive cash flows. For example, techniques such as new inventive

foreign exchange risk and interest tariffs risk prevarication are increasingly becoming famous in

the management of risk within most corporations in contemporary society.

As a business expands globally, they get open to more significant risks with tariffs of

exchange disparities (Waring 2016). Consequently, such organisations get faced with challenges

such as fluctuations of interest tariffs. It is, therefore, important that such corporations in Africa

remain competitive in the financial service business through pertinent risk management

practices. Hence, the foreign exchange risk and interest rate management eventually influence

the financial performance of most corporations. The research seeks to bridge the knowledge gap

through an analysis of how the financial industries in Africa handle foreign exchange tariffs and

interest tariffs risks. The dissertation, therefore, adopts the following research questions in the

guidance of the study: How do African corporations manage their foreign exchange exposure?

What are the derivatives that African corporations use to mitigate financial risks? How does the

financial industry in Africa manage foreign exchange rate risks? How does the financial sector in

Africa handle interest rate risks?

1.3 Objectives

1.3.1 The general Objectives

The general aim of the dissertation was to determine and look at the way corporations in Africa

handle interest tariff exposure and international trade challenges.

1.3.2 Specific Objectives

i. To study the correlation between financial derivatives and risk mismanagement in the

African financial industry

ii. To determine how the financial sector in Africa can handle foreign exchange, tariffs

risks, and interest tariffs risks.

1.4 Significance of the Study

The investigation will contribute to the literature in the study of financial risk

management in the African context. Moreover, it will enrich the knowledge of Risk and Treasury

managers on the management of risk, particularly the techniques linked to foreign exchange risk

management in the African corporation settings. Additionally, the findings of the research will

provide a useful source of information in the execution of foreign exchange risk management

regulations for most treasury administrators of various financial institutions. Again, the study

will be helpful to investors since it will offer information about the risk associated with the

foreign exchange that will ultimately help in making sound decisions, especially during this

amplified fiscal environment instability epoch. The literature and the recommendations of the

study will be pivotal in future to researchers within the area of study.

Africa and Risk Control 8

1.5 Methodology Outline

The goal of this research was to investigate risk control strategies, specifically foreign

exchange and interest rate risk management in the African context. Data technique was through

secondary sources collected from annual reports from company websites, financial statements,

and accessed government statistics on economic trends from respective countries. Data collection

was conducted of 20 financial corporations across Africa from the year 2001 to 2018.

Furthermore, the study tested a hypothesis employing correlation coefficients and regression

analysis. The dissertation adopted the descriptive research method, targeting the 20 companies

across Africa. The study made use of the sampling approach to choose all the 20 companies

across Africa for increased convenience due to the extensive population coverage. The research

used both online and secondary data as sources of data. The analysis of multiple linear

regression got applied to observe the influence extent of the independent variable on the

dependent variable based on the multivariate model. The entire data collection process followed

the confidentiality and anonymity of ethical issues.

1.6 Overview

This study consists of five chapters. It starts with an introduction describing the nature,

background, motivations as well as the problem of the research title, followed by research

objectives and the significance of the research. The next section reviews previous works relevant

to this research. The chapter contains a theoretical framework on financial derivatives and risk

mismanagement in the African financial industry. Section three of this research explains the

applied methodology followed during the study and approaches in a broad scope. Chapter four

presents the analysis of the findings of this study validated based on statistical information.

Finally, chapter five concludes with a summary on discussion, conclusion and recommendation

for extending presents results and lessons of this research.

CHAPTER TWO

2.0 LITERATURE REVIEW

2.1 Introduction

This section outlines the significance of foreign exchange and interest rate risk

management, various currency risks categories as well as the techniques applied in managing the

risk of foreign exchange as discovered by several researchers. Again, the section covers an

extensive literature review, plus the theoretical context.

2.2 Theoretical Review

There exist a variety of concepts that propose the insignificance of handling the

transformations risks in exchange rates. The ideas offer that variations in the prices of exchange

get leveled in a specific form or the other.

Africa and Risk Control 9

2.2.1 The Theory of Foreign Exposure

Contemporary the theory of foreign exposure suggests that exchange rate of fluctuation

should influence a multinational company value majorly through net foreign assets and market

sales, that should get dominated within the local currency of the parent company (Hutson and

Stevenson 2010,p.105). Regardless of that, the previous empirical studies on the subject, though

confined to corporations with substantial operations internationally, fail to indicate a

considerable fluctuation impact on the rates of exchange on the multinational corporations' stock

price (Hutson and Stevenson 2010, p.120). However, Hutson and Laing (2014, p.97) affirm that

more recent studies are more reliable with the theory of finance and discover that the movements

of exchange rates, through their effects on net asset values and sales, provide a crucial factor in

establishing the worth of an institution.

2.2.2 Interest Rate Parity Theory

The theory affirms that the rate of interest disparity of two nations is equal to the

difference between the spot exchange rate and the rate of forwarding exchange (Engel 2014,

p.453). Therefore any differential of the two country's' interest rate gets equalized by the measure

of the rising currency exchange rates. Interest rate parity is essential in foreign exchange

markets, spot exchange rates, linking interest rates, and foreign exchange rates (Engel 2014,

p.459). The concept of economic connecting the disparity in interest rate among nations to

subsequent changes in exchange rate often breaks down, as registered in the current float. As a

result, exchange rates fluctuations are get no longer managed by the differential of international

interest.

According to Engel (2014, p.460), other studies suggest that theories such as monetary

model and purchasing power parity, again add some random walk exchange rate forecasts, at

least in at horizons of not more than a year. The studies reported solid dismissals of disclosed

interest rate parity. In contrary, Ichiue and Koyama (2011, p.1437) propose that there exists

unbiased prediction in forwarding exchange rates when measuring rates of the subsequent spot,

and there exists no advanced premium puzzle.

2.2.3 Theory of International Fisher Effect (IFE)

It is an economic model developed in 1930 by Irving Fisher. The model states that the

anticipated disparity between the rate of exchange of two currencies is almost the same as the

counties' nominal rates of interest. This theory utilizes market interest rates instead of inflation

rates to describe the reasons for the changes in exchange rates over time. The method argues that

real interest rates are not dependent on other monetary variables like changes in the fiscal

policies of a country. In its argument, it is clear that actual rates of interest across nations are the

same because of the probability of arbitrage prospects between the economic markets that

happen in the form of flows of capital. IFE, therefore, provides an indication of better health of a

specific currency in the global economy.

The assumption here is that nations having lower rates of interest are also likely to

experience reduced inflation levels (El Khawaga, Esam and H1ammam 2013, p.140). This low

level of inflation can eventually lead to a rise in the real value of the associated currency in

comparison with other countries. On the contrary, the equality of the actual rate of interest

signifies that the nation with an increased rate of interest ought to have a raised inflation rate.

Subsequently, this causes depreciation in the real value of the nation's currency over time. IFE,

therefore, expounds on the exchange rate expectation theory connecting between the relative rate

of interest and foreign exchange rates. The difference between the nominal rates of interest

between the two nations is likely to reflect on fluctuations in the exchange rate. According to El

Africa and Risk Control 10

Khawaga, Esam and Hammam (2013, p.146), there is a close relationship between the IFE and

The Fisher Effect. Will Kenton argues that the two models are closely related but are not

interchangeable.

The Fisher Effect states that the nominal interest rate represents the combination of both

the real return rate and the anticipated inflation rate. On the other hand, IFE expounds on the

theory proposing that changes in currency are proportional to the variance between the two

countries' nominal measure of interests. Therefore, if IFE holds, rates of interest in improving

currencies tend to low enough, and in depreciating currencies high enough, to balance projected

currency losses or gains. However, the IFE does not get considered as the best predictor of

changes in the short run, particularly in spot exchange rates (El Khawaga, Esam and Hammam

2013, p.159). The PPP theory helps in answering the question of whether the difference in

interest rate assists in predicting the future movement of currency.

2.2.4 Purchasing Power Parity (PPP)

This theory argues the law of one price that all similar goods ought to have the same

amount. PPT got developed first by Gustav Cassel, a Swedish economist in 1920s. It compares

the relationship between different nations' currencies (Iyke and Odhiambo, 2017, p.91). The PPP

concept is that two currencies are at par or equilibrium if a basket of products gets priced

similarly in both nations, considering the exchange rates. The theorem proposes that a relative

change in PPT for any two currencies estimated as a price ratio of exchanged products would get

calculated by changes in the rates of equilibrium between currencies under a floating trading

regime. This model assumes that the measure of exchange between paired nations perceived

within the market of foreign exchange that get considered in the PPT comparisons. Hence, an

equal amount of products get purchased in either currency using the same initial amounts of

funds.

The assumptions are that all goods are tradable, identical, and there exists no cost of

transportation, taxes, and information gaps. Again, the rates of exchange only get affected by the

relative proportions of inflations (Iyke and Odhiambo 2017, p.95). The theory indicates that a

rise in the level of price of a nation will result in its exchange rate depreciation concerning other

countries. Thus, maintaining the price levels of similar products the same trading states. It,

therefore, suggests that changes in exchange rates are offset by inflation, as follows from the law

of one price. Currencies get considered as assets; therefore, rates of exchange are asset prices

which adjust to balance international trade within commercial assets. Similar to other assets

prices, exchange rates get evaluated through projections on the future. This technique is entitled

asset approach because the currencies get considered as assets.

The notion of PPP enables one to predict what the rate of exchange between two

countries would look like to balance the purchasing potency of the involved states. PPP concept

is therefore essential in the management strategies of a corporation since it allows for

comparison between two nations. Moreover, they act relatively constant and can only change

slightly in the long run. Again, the exchange rates incline to make movements in a common trend

of the exchange rate of PPP over the years. Hence, there exists some value of predicting the

direction the exchange rate can shift within the long run.

2.3 Indicators of Financial Performance of Corporations

The performance of a corporate gets greatly influenced by stochastic variables which

define the volume of output. The factors consist of both the external and internal determinants.

These determinants are adversely affected by the management strategies of a company. The

macro elements are beyond the management team and influence the profit of the corporation.

Africa and Risk Control 11

Internal determinants are the variables that impact the market value of a specific institution.

These factors differ from one corporation to the other and within the scope of the organizations

to manipulate. The micro factors including the size of capital, asset quality, the policy of interest

rate, the quality of management and liquidity.

2.3.1 Internal Factors Affecting Corporations

2.3.1.1 The Availability of Capital

Capital adequacy affects the level of a company's profitability. It is the allocation of its

fund in support of the business and serves as a buffer during adverse situations. Capital makes

liquidity for the company since the deposits are fragile and vulnerable to company

runs.Furthermore, more substantial money decreases the distress chances of an organization.

However, its drawbacks involve inducing weak demand for liability. An organization should be

able to withstand losses during crises. The losses get determined through capital adequacy ratio

(Mwangi and Murigu 2015, p.292). The managers should, therefore, adopt a strategy that enables

them to generate sources of fund capital availability.

2.3.1.2 Quality of Assets

Banks assets include investments, fixed and current assets as well as credit portfolio.

Delinquent loans can result in losses to a business. It is a significant concern of large companies

to keep the rate of nonperforming loans at a reduced level since the profitability of corporations

such as banks get affected at a high nonperforming loan (Mwangi and Murigu 2015, p.291)

2.3.1.3 Efficiency of Management

It gets represented by differential ratios of finance such as total loan and asset growth as

well as the rate of earning growth. Operation efficiency is an essential element in the quality

management dimension. Management performance gets frequently assessed through subjective

evaluation systems of management, control systems, organizational discipline and quality of

staff. The administration should deploy its resources effectively, thereby reduction in operating

costs. Operating costs can get determined through financial ratios. The increase in the price of

operation to total revenue, the higher the efficient management is regarding income generation

and operational efficiency (Mwangi and Murigu 2015, p.290). Therefore, the quality of

governance affects business profitability by determining the operating expenses level.

2.3.2 Macroeconomic Factors

Macroeconomic variables including interest rate, GDP and political instability can

broadly impact on the financial performance of an institution. For example, the GDP trend

influences the demand for a company's asset. When GDP declines in growth, the need for credit

reduces and subsequently, negatively affects the profitability of an organization. On the contrary,

a growing economy signified by the growth in GDP increases credit demand because of the

business cycle nature. The need for credit is low during the recession compared to during boom

(Mwangi and Murigu 2015, p.289).

2.4 Empirical Review

. Chue (2008) researched to analyze the performance of foreign exchange risk

management techniques applied by airlines enterprises in East Africa. The study consisted of an

analysis of particular performance strategies employed in the management of airline industries in

east Africa. The study included the use of derivatives, payment matching and invoicing, leading,

and lagging. The research was useful to the sector of finance, specifically in the line of FERM

Africa and Risk Control 12

and the scantiness of the empirical literature proves to be a preventive factor. The scope of the

investigation involved finance because it is directly related to foreign exchange management.

The part of the literature review was characterized by both theoretical and empirical and

theoretical literature on foreign exchange risk performance techniques in control. Again, it

involved a critical evaluation of sources with data related to the problem of research as well as a

summary of the bridges to be further researched. The framework of the concept of the study

contained four independent variables, dependent variable, as well as intervening variable (central

bank of Africa). A descriptive study design got employed. Again, it involved a census on the

whole population target of 15 registered airline businesses across east Africa.

Statistical data which got obtained through questionnaire was collected got analyzed

using SPSS and descriptive statistics. The results got tabulated in charts, frequency tables, and

percentages as well as graphs. Both the airline business in east Africa and international business

companies benefited from the results of the study. The researcher concluded from the research

that, the variables; payment matching, leading and lagging and invoicing and currency clause

were the significant techniques of foreign exchange risk performance utilized by the majority of

airline organizations as confirmed by the majority of the respondents.

Omran (2011) studied the relationship between the financial performance of Commercial

banks of Africa and foreign exchange trading. The research aimed to determine how foreign

exchange trading relates to the financial performance of 40 major commercial banks in Africa.

The study employed a research design survey of all the 40 banks that were the center of the

research. Secondary sources of data got used, including yearly commercial banks financial

report, and foreign exchange information (swaps, spot trading, and currency forwards) reported

to Bank of Africa. Descriptive data and Pearson correlations, as well as the analysis of multiple

linear regression, got applied. The research summarized that; forwards and currency swaps get

negatively connected with ROA. On the other hand, the relationship between financial

performance and currency spot is positive. Therefore, forwards, swaps and spots have a

significant connection with the performance of commercial banks.

Kasman (2011) did a study to evaluate the relationship between the volatility of exchange

rates and financial performance. The research involves the production of multinational

corporations in South Africa. Kasman discovered that multinational company's financial

performance and exchange rate volatility strongly relate in South Africa. These findings were

observed due to the disparity between financial reporting and trading currency.

Chiira (2006) researched foreign exchange risk management by oil companies in Kenya.

The study had various limitations. For example, the scope of the study got limited to the sector of

the oil, and therefore, its results do not represent other sectors. Again, the adoption of the

qualitative methodological technique in the study prevented substantive statistical analysis in

supporting the research findings. Similar to Gebhardt and Bodnar (1999), the main results of this

research is the conveyed correlation between usage of derivatives instruments and the firm size.

The investigation established that five of six corporations having over $100,000 in revenue

operated with more derivatives, whereas two of nine institutions with $100,000 or less in revenue

performed with fewer derivatives. The study found that none of the institutions with not more

than $50,000 in revenue used the derivatives. The findings offer evidence of a correlation

between the size of a corporation as determined by income and practices in the foreign exchange

risk management and the application of derivative instruments. In contrast, this research made an

investigation of whether there exists cross-sector FERM practices evidence; however, the size of

a firm is also a consideration of the study. This process was carried out through discerning

Africa and Risk Control 13

variations across sectors in terms of methods and strategies applied in the management of foreign

exchange risk.

2.5 Risk Management Strategies

2.5.1 Forward Contracts

It is an agreement to sell or purchase a particular foreign currency amount at a set price

for future date settlement, or within a preset window period. It helps investors control the risk

characteristic in currency markets by predetermining the date and rate of purchase or sale of

particular foreign exchange amount. Therefore, the portfolio gets covered against a likely move

of unfavorable currency, and no additional complications of price in execution from getting

involved in a spot trade (Campbell, Serfaty‐De Medeiros and Viceira 2010, p.98). The widely

adopted method is forward exchange contracts since a firm gets fully hedged when using

forwards. However, due to the high cost of this tool, there exist risks such as settlement risk and

counterparty risk, which can hinder firms from hedging their exposures using forward contracts

entirely.

2.5.2 Cross- Currency Swaps

This strategy often occurs when two parties, for example, a bank and a company

exchange payments controlled under single currency for payments dominated or controlled in

another. The main aim of swaps is to replace scheduled cash flows in unwanted currency with

outflows and inflows in the desired money to raise capital in no significant revenue currencies.

2.5.3 Options

It involves the reduction of potential risk exposure as it implicates the counterparts

having free choice to foreign exchange currencies at a particular date and time. The buyer can

opt for a call option while the writer may make a sale of a put option (Allayannis, & Ofek. 2001,

p. 274).

2.5.4 Leading and Lagging

The two involve payments acceleration from weak currency states and making delay of

inflows from stronger currency nations. Nevertheless, lead and lag management strategies can

become a challenge in implementation since it entails one party benefitting while the other loses

(Folker, Schulman and Baylies 2014, p.355). Hence, the profits gained from having the

advantage of exchange may get overruled by the event of losing business because of the zero-

sum nature of the approach. Moreover, this method has developed as a hedging strategy against

the adverse effect of rate of exchange movements.

2.5.5 Price Adjustments

This strategy entails alterations of prices in differential manners. It gets used in countries

which get exposed to high devaluation rates as well as the inefficient derivative market.

However, its limitation is that prices cannot happen to get raised without considering competitors

since a rise in price will let clients opt for the same cheaper product from a competitor (Madura

2010). Therefore, flexibility through price adjustments is vital when passing through changes in

the input prices to consumers within a corporation.

2.6 Foreign Exchange Risk Management (FERM)

This risk is due to the disparity between the assets that corporations hold. Also, the debts

that fund its balance sheet (often dominated in a stronger currency or US dollar). Unpredicted

local currency depreciation against the US dollar can intensely raise the servicing debt cost in

relation to revenues. Besides, it negatively impacts a corporation's creditworthiness, and this

gives the institutions the capability to increase additional funds, plus make a negative net

Africa and Risk Control 14

income. This negative net income can generate a severe consequence on the financial stability of

a corporation in a long- term.

Most African corporations are particularly vulnerable to the risk of foreign exchange

because they often operate in developing nations where the currency depreciation risk gets very

high. Moreover, extreme depreciation of currency tends to get much correlated with overall local

economic conditions deterioration. Subsequently, this decline can result in increased loan

delinquencies as well as profitability reduction of financial activities. According to Adelegan

(2009, p.12), most of the organizations in Africa use the instruments of derivatives for hedging

and that exposure of translation reflects on the foreign exchange exposure that seems to concern

most firms. Additionally, a study conducted by Chance and Brooks (2015) discovered that most

institutions in Africa have less consideration of the real effect on the changing rates on the

company’s competitive position. Bartram (2017) suggested that there exist a substantial

correlation between the exchange rate sensitivity of a firm and the extent level to which it funds

itself and trades sources internationally.

Corporations in Africa get also affected by the transfer and convertibility risks. These

risks can be as a result of the government’s restrictions. These restrictions occur on letting a

foreign currency available for transferring or sale of hard currency outside the nation.

Consequently, the existing corporations within the economy may have the financial potential to

make payments of its hard money, but cannot do so due to the restrictions from the national

governments. Hence, corporations also suffer from the convertibility and remittance (transfer)

risk that get related to foreign exchange risk.

As a result of the associated risks, African corporations exposed to foreign exchange risks

may opt for three options. For example, first, some corporations may choose to accept the

variation consequences in currency values or the probability that their national administration

may enact restrictions on the transfer or the availability of foreign currency. Therefore, such

corporations opt to do nothing. Corporations can opt for another path which entails ‘hedging’

against their exposure. For instance, the firms can buy a financial instrument that will guard the

institution against the costs of undesirable activities within the rates of foreign exchange. Finally,

a company can partly hedge against the risk of foreign exchange or restrict the exposure of their

hard currency to certain set levels (Deng, Elyasiani and Mao 2017, p.115). Therefore, hedging

against risk is a healthy strategy in managing the foreign exchange risks within the African

financial industry.

2.7 Interest Rate Risk Management

According to Griffith-Jones (2016, p.135) asserts that there is nothing wrong with the

risks. An important thing is the handling of the risks so that they do not negatively affect the

state of the company financially. This study, therefore, explores the strategies adopted by the

African financial system on mitigation of financial risks. To achieve an effective operating

financial system, fiscal problems, including interest rates and foreign exchange, need to get

addressed. Moreover, Madura (2010, p. 47) suggests that the performance of hedging strategies

often differ among institutions. This difference is as a result of the management principles and

risks perception within an organization. Stacy and Williamson, (2010, p. 81) posit that it is

essential to predetermine a risk.

Extreme interest risk rate can have adverse effects on an institution’s capital base.

Hence, interest rate changes can have a significant threat to the capital, earnings, and economic

Africa and Risk Control 15

value of a financial company. The main objective of IRRM is to keep a business’ interest rate

risk exposure contained within self-made parameters over a wide range of probability of interest

rate changes. Enterprises possessing the higher likelihood of managing risks predetermine their

risk, unlike those uninformed of the challenges. In this study, the dangers that got covered were

assumed to be as a result of cross-currency swaps, adjustment of prices, forward contracts,

options, and leading and lagging. These currency risks got used as the variables for the study.

Therefore, this research aims at bridging the gap addition of more recent statistics and by giving

information on management strategies on foreign exchange risk tariff as well as interest rate

tariff in African Financial Organizations.

More developed nations adopt sophisticated methods in managing financial risks.

However, there is limited usage of the same derivatives in developing countries (Madura 2010,

p. 50). There has been a growth of management of financial risks recently among developing

countries. This development of management of risks is significant in matching the various

assessments and risk characteristics. Madura (2010, p. 50) asserts that derivatives used in

financial risks are believed to come from the underlying assets such as financial assets and

commodities. The management board should understand the level and nature of taken rate of

interest within a corporation. The Board of Directors therefore approves and formulates a wide

range of commercial strategies. Those strategies influence the interest rate risk, plus approving

the general policies and guaranteeing that the board has the required procedures in identifying,

measure, and control the risk. Therefore, commercial organizations ought to have enough system

of information needed in measurements, monitoring, control, and reporting exposures of interest

rates. The reports should consist of any approved responsibility violations by managers when

handling vulnerabilities or unapproved financing devices as well as any exclusion stressed by the

internal auditor (Hutson and Stevenson 2010, p.107).

Getting loans at a floating rate of interest exposes borrowers to the risk of interest rate

that in an increasing interest rate setting results to escalated debt servicing charges. As the

standard of reference changes with time, debtors who make payments on floating rates of interest

realizes fluctuations on amounts of their attention, and this depends on the conditions of the

market. There exists a negative effect on economic performance due to the increasing interest

rates. Thereby, exerting pressure on the nation’s budget and imposes either higher deficits or

spending cuts (Hutson and Laing 2014, p.100). Developing countries, for example, in Africa,

often get access to limited financial potential to bear the interest rate risk.

The mitigation of interest rate risk can happen through decreasing the exposure of the

portfolio of the government to floating rates. This reduction can occur by either through

modifying the characteristic of the outstanding debt of floating rate or issuing a revised fixed-rate

mortgage. However, these techniques only prove vital to borrowers in a situation when present

forward rates go below the actual prices in the future. The idea to fix the rate of interest ought to

rely on a cost –risk analysis as a measure of a strategy of robust debt management set by the

national government. Well-handled debt management strategies assist governments in lower

financial risk exposure.

Many corporations establish ranges for vital risk indicators or targets which guide the

borrowing operations as well as other debt transactions. For example, the government may put a

60 percent holding targets of the total debt within the sovereign portfolio of debt in fixed-rate

(Madura 2010). Decreasing exposure to rate of interest rate risk through give out new debt can

take more time in comparison to a derivative solution — however, most borrowers in developing

Africa and Risk Control 16

nations. For example, African financial institutions have limited derivatives access, mainly state-

owned business, as well as sub-national borrowers.

A strategy towards achieving the target mix of floating against fixed-rate debt is to fix

the rate of interest on its IBRD loans, based on a floating rate of reference. IBRD allows

borrowers to adjust their interest rate using solutions including conversions, interest rate swaps,

as well as interest rate collars and caps (Dang et al. 2010, p. 2375). Therefore, IBRD can assist

corporations in reducing the floating interest rate of exposure as part of the management strategy

of debts.

2.8 Financial Derivatives and Risk Mismanagement in the African Financial Industry

Any business company is inherent to the risk and therefore, a good management strategy

is a crucial aspect in running a successful enterprise. There exist various levels of risk control for

multiple organizations depending on the type of risk. Despite little study on the use of derivatives

in African corporations, there exist few active derivative markets across Africa. An estimated 83

percent of corporations using derivatives do so to control the foreign currencies risk, whereas 76

percent of the companies make use of derivatives in hedging against interest rate changes. Most

nations in Africa refrained from the use of derivatives because of the lack of exposure to interest

rate movements, commodity and exchange rates as well as equity price risks.

Additionally, the establishment and maintenance cost of derivatives program and

transaction costs are significant concerns for the little adoption of the derivative use among

African countries. According to Adelegan (2009), there exists a considerable growth of

derivatives in South Africa, which provides active illiquid static income markets as well as

foreign currency markets. Consequently, the growth of derivatives in South Africa has since

guided the other countries across Africa, which now focuses on Regional Corporation in the

trading and listing of instruments of derivatives.

Derivatives are essential in the management of risk exposure within companies. For

example, among the derivatives instruments, OTC forwards get widely used by companies

hedging foreign exchange risk. On the other hand, most corporations prefer OTC swaps in

managing interest rate risk (Adelegan 2009). Institutions from less developed nations with less

liquid derivative market face fewer chances in hedging, which apply to even large organizations.

The low derivative use rate in Africa can get attributed to the limited presence of active

derivative markets as well as the absence of adequate market infrastructures across Africa.

Therefore, due to the challenges the African companies face in managing the risks, the best way

to handle such problems is to try to anticipate probable risks, evaluate the possible effect and get

prepared with an effective plan to respond to undesirable events.

2.9 Summary of the Chapter

Despite the significant effects of FERM on outflows and inflows of cash, it is still a new

phenomenon in Africa. As a result, few pieces of research have been done in the area, especially

in the management strategies used by most corporations in control of interest rate risk (IRRM)

and FERM. In nations where research have got conducted on the management strategies used by

African corporations, scholars have used a diversity of techniques to rationalize the existence of

the relationship between the two variables and their effect on the performance of the

corporations. FERM get considered to constitute a set of complicated indicators that encounter a

considerable quantified error because of the custom complex on the interaction between the

performance pointers and the variables of risk management. The main aim of this research is to

Africa and Risk Control 17

define some of the management strategies employed by African corporations like, the use of

swaps, forwards, options, price adjustments, and leading and lagging.

The overall conclusions can get observed from the review of the literature of foreign

exchange risk and interest rate risk and corporations. First, companies require extra funding to

balance the demand, plus the capital of debt is the likely source funding source. Second, the

existing FERM practices are relatively expensive either to the organization or the client.

However, most of the conducted research on the strategies of management majorly concentrates

on developed counties whose financial situation is dissimilar from the developing nations such as

African countries. This research, therefore, strives to increase knowledge on the management

strategies of FERM and IRRM among corporations in Africa.

CHAPTER THREE

3.0 RESEARCH METHODOLOGY

3.1 Introduction

The changes in the financial market of the world have hugely affected its stability. The

transformation of most organizations globally to international trade has resulted in several arising

risks that involve both foreign exchange and interest rate risks. The control of these risks is quite

a complicated technique. It is therefore essential to have an understanding of the needs that

various financial institutions require both internal and external surrounding as well as their

exposure to the commercial market. Currently, most of the financial institutions make

improvements in risk management. However, there still exist challenges within the areas. The

financial industry in Africa gets faced with various challenges. For example, these challenges

include the vast extent of simple setup, inadequate management strategies tools such as swaps,

futures, and options which are vital in hedging currency risks. A lot of scholarly research exists

concerning these risks; however, there is limited research on a similar study in the African

economy.

The gap in duration is broad to measure the risks of foreign exchange and interest rate,

which predicts several changes in the asset value and liabilities. This change responds to the

price of interest shock. The gap creates a reflection of the assets pricing frequency and liabilities,

plus the embedded call options value. This duration provides risk measurements by calculating

particular interest cash flows of corporations for a given scenario of the interest rate. The

research uses the net interest income to measure for the corporation's profitability as a more

significant section of their assets as advances to loans from more prominent institutions.

This research seeks to explore the management of financial risks by analysis of foreign

exchange risk tariff and interest rate tariff strategies in African financial system and, analysis of

how the duty affects the financial performance of the African corporations. Therefore, to obtain

accurate information on the research topic, the following research questions got prepared to aid

in the process. First, how do African corporations manage their interest rate and foreign

exchange risk exposure? Second, what are the derivatives that African corporations use to

mitigate financial risks? And, what is the impact of foreign exchange and interest rate risk

management on the financial performance of African financial institutions? This chapter

discusses the description of the methodology of the study and detailed information used in the

completion of the research. The general objective of this research is to determine the FERM and

IRRM in the African financial industry. This stage involves decisions on the manner the study

got conducted as well as how the approach towards respondents and duration taken to

completion of the study.

Africa and Risk Control 18

This research identified both dependent and independent variables for investigation of the

objectives of the study. The dependent variable was the institutions performance and measured

using ROA. ROA got measur5ed by incomes before interest as well tax on total assets. The

independent variables of the study are the financial risks, including the risk of interest rate

(IRRM) and foreign exchange (FERM). FERM got measured by exchange ratio while IRRM got

weighed by the margin of the interest rate.

There are two ways an organization can opt to control its risks; the institution may decide

to manage its risks holistically, all at once or one at a time. When there is an increase in the

foreign exchange risks and interest rate risks, then the ROA of business organizations reduces

(El Khawaga, Esam and Hammam 2013, p150). The variables of the 20 companies got measured

solely for each institution for the duration of seventeen years from 2001 to 2008.

This chapter presents a variety of phases and stages that got followed in the completion

of the study. In the section, several decisions made concerned how the research was to get

executed plus the approaches towards respondents. The chapter describes the research design, the

targeted population, procedure of sampling, instruments used during the study, methods applied

in data collection, and data analysis. The decisions made in this section mostly included the

manner at which the research got executed, and the approaches used towards the respondents.

This stage also includes how the study got completed and the duration of the study.

3.2 Research Design

The research design refers to a plan or scheme that get applied in generating solutions to

research problems Ngechu (2004, p. 12). It is how the study gets conducted through procedure

presentation as well as the techniques used in handling the problem. The central tendency

measurements, including range, mean, skewness, standard deviations, and kurtosis, are among

the analyzed characteristics. The design helps in the summary of independent variable features of

the provided observation on how the financial performance relate to interest rate tariff and

foreign exchange tariff.

The study employed a descriptive research design. The descriptive survey study

represents a precise person profile, events, as well as characteristics, account, for instance,

opinions, beliefs, behaviors, abilities, and knowledge of a particular person, group or even

situation (Apuke 2017, p.41). This method got preferred since it guaranteed a full situation

description since it offers in-depth research of foreign exchange and interest rate risk

management in African financial business, hence ensuring minimal biases in the data collection.

3.3 Sample Design

Sample design is a mathematical function that includes the description of the probability

of a specific sample selected from a population. This study preferred random probability

technique due to its minimization of the possibility of bias. The biases get avoided because the

method offers every population member an equal chance of being selected. The simple random

technique is n/N, where n, is the size of the sample, while N represents the total population.

Therefore, prior knowledge of the community is essential. For this study, many African countries

could get studied with each having their financial institutions. It would be expensive due to time-

consuming and use of a lot of resources if the whole population would get examined. This

research, therefore, used only 20 companies, hence enabling the effectiveness of the sampling

method.

Africa and Risk Control 19

3.4 Target Population

A population refers to a set of people, elements, events, services, or group of things that

get studies to get certain desired information (Ngechu 2004, p.14). The target population of this

research consisted of 20 financial corporations across Africa from the year 2001 to 2018. The

study adopted a sampling approach in picking all the 20 commercial companies across Africa

due to a large number of selected corporations in Africa. The seventeen years of study will

generate 216 data points obtained by the monthly average.

3.5 Research Methods

Research methods provide a systematic strategy used in the implementation of a plan in

answering research questions. According to Apuke (2017, p. 40), the difference between a

research method and research design is that, while research design is just a plan giving solutions

to research problems, research methods only provides an implementation strategy of a program

in answering research questions. Any sector of finance draws attention to various ways of

conducting a study depending on the aims of the necessary exposition. For example, this research

adopted a quantitative approach to gathering data.

Quantitative research technique involves obtaining numerical data that aids in the

measurement of the problem for statistical purposes. This technique tests the hypothesis

objectively that is significant for the study. The method got chosen because it is not subjective

and needs less time, unlike, the qualitative approach that consumes a lot of time because of the

involvement in rigorous fieldwork. The study adopted various quantitative methods, such as

online research and doing surveys to obtain data.

Studies have been carried out to access derivative use in African financial system as a

strategy of risk mitigation out of which gave some information. This study did correlational,

comparative, and computational analysis to relate to variables. Again, the study employed

mathematical approaches in conducting correlation that allowed easy analysis of various degrees

and trends of connection among the variables in the African financial economy. Besides, data got

collecting through online sources such as Online Hoovers as well as Yahoo Finance, which

provided information on the African financial market environment.

Online data collection is much reliable since it allows for accurate, peer-reviewed

information. The website offered readily available data and had updated financial statements of

different organizations such as companies, corporations, and banks. The government also aided

in providing information on the state of the economy. Validation of the authenticity of the data

involved a lot of care since some website contains incorrect information. Screening and sorting

data further avoided the minimization of errors. Also, government agencies got approached so as

obtain accurate information n concerning population and economic situation of the respective

target nations. The government agencies got contacted by making special requests.

Another method of obtaining quantitative data for this study involved the use of

published sources. These sources consisted of reports from publications from government,

research centers, and higher learning institutions. Others sources of books included reports from

banks and trade unions. Ministries of finance and planning from various countries formed an

integral part of providing government publications. These publications proved vital in obtaining

accurate government figures and information in terms of foreign exchange reports and

regulations of interest rates.

These international banks provided reports on financial situations of institutions within

Africa. Information such as income statements and balance sheets had to get comprehensively

scrutinized in the retrieval of reliable information for analysis. Data from commercial banks,

Africa and Risk Control 20

companies, and corporations across Africa also proved relevant for the study. The data from the

institutions provided import and export information that indicated the benefits and losses due to

foreign exchange and interest rate tariffs.

The research used secondary data. This data comprised of information that has been

obtained by other scholars for different purposes but is relevant to this study. Secondary data

involved reports from international financial banks such as the World Bank, IMF, and UNESCO

for the period between 2001 and 2018. The banks got chosen since they offer an updated study of

every country's economic status, hence providing updated and accurate results. Advantages of

this method are its degree of reliability and validity. It is readily available from other works in

previous studies, hence making it easier to conduct further research (Apuke 2017, p.41). Again

the method is cost-efficient and time-saving. It is, therefore, a method since much of the

background work required is available. However, this method can present drawbacks, too. For

example, the information may be out of date hence inaccurate (Apuke 2017, p.41).

Additionally, other relevant reports got obtained from commercial banks across Africa.

The research considered the balance sheets, export, and import data for the selected

organizations. All the corporations under study have been consistently in business from the study

period and got included to ascertain that the sampling frame is present and complete.

3.6 Data Collection

The study used secondary data because the nature of the research never needed primary

data. Secondary data constituted sources collected by other scholars for different objectives but

still relevant to this study. The data got collected from yearly reports that got submitted to the

central banks by the African Financial Institutions in the sampled countries from their websites.

The websites of the respective countries got navigated and financial statements downloaded.

Analysis of the reports got done after six months of the duration of the study. Data for

commercial corporations were collected because they are readily available from the websites.

Besides, this research made use of Datastream as a financial database in the provision of

meaningful information on derivatives as well as exchange rates and financial data of the

selected corporates under study. The study used the datastream sources of IMF as well as the

national governments of the respective countries. Datastream provides daily updates on the

everyday prices of stocks and trading volumes hence proved relevant in providing information

on foreign exchange and interest rates of the corporations. This information is useful for the

future management strategies of African financial institutions.

3.6.1 Data Collection Procedure

It was easier to obtain data from central banks because it is required that all existing banks within

an economy submit an annual report to central banks. This data therefore got used in the

assessment of the impact of financial risks to commercial institutions financial performance. The

data got obtained for seventeen years from 2001 to 2018. The panel data involved cross-sectional

data and time series. Data of Cross-sectional represented twenty African corporations across

Africa, whereas time series data symbolized the duration of time from 2001 to 2018.

Africa and Risk Control 21

3.7 Data Analysis

The data analysis method entails the use of suitable analytical tools in addressing the

study research questions. The research involved an evaluation of foreign exchange and interest

risk management to determine and look at how corporations in Africa handle interest tariff

exposure and international trade challenges. Data obtained from the research got edited, sorted

and corded to get the needed accuracy before entering it into SPSS (version 21) to generate the

charts, tables of frequency, correlations as well as regressions which aided the analysis.

The software of SPSS got used for the analysis of data that provides a quicker and accurate

analysis of data as well as offering proper management and organization of data. SPSS software

was used to generate correlations, frequency tables, charts, and regressions that aided during the

process of analysis of data. Correlations gave the extent of the relationship between or among the

variable. This relationship is vital in determining the influence of one variable on another. The

tables of frequency provided the changes in the interest rates and foreign exchange rates

throughout the research.

The analysis of multiple linear regression got applied to offer an investigation of the

effects of an independent variable on the dependent variable. The multivariate model was used in

regression that constituted options, leading and lagging, adjustment of prices, cross-currency

swaps, and forward contracts. Regression analysis gave the coefficient of every independent

variable, therefore providing the level of its impact on the dependent variable. The multivariate

statistical analysis examines relationships among various variables at the same time. It is

therefore desirable since it lets the researcher predict the effect of change in particular variables

based on the outcome of one variable. As a result, it provides specific merit over other types of

analysis. The accuracy of this technique majorly comes down to the kind of data used

(Tonidandel, and LeBreton 2011, p.2). Therefore, incomplete data may limit its accuracy, and a

researcher may falsely assume that a correlation is a causation.

The analysis of the multiple linear regression was applied to investigate the independent

variable level of influence on the dependent variables. The model of regression is a multivariate

stating the financial corporations ROA as a function of the chosen foreign exchange and interest

risk management strategies.

3.7.1 Analytical Model

The research adopted both the dependent and independent variable using the following

regression function;

Y = β0+ β1X1+ β2X2+ β3X3+ β4X4 + β4X4+ β5X5 + β6X6 + ε………….. (1)

Where:

Y= ROA of the financial institutions in Africa, which is a profitability measure to give the

dependent variable value.

β0 -Y Constant or intercept

X1-Forward Contracts, this factor was measured considering the change in the percentage of the

value market agreed of currency and the agreement between parties on selling or buying a

particular currency amount at a certain rate on a specified future date.

X2-Cross-Currency swaps got obtained by the percentage value change of the currency as a

result of currency exchanges.

X3–Options, its measurement got obtained by considering the premium change prepaid as a way

of reducing foreign exchange risk exposure.

Africa and Risk Control 22

X4-Leading and Lagging was measured by considering the value of loss from soft currency

depreciation and gains from the appreciated hard currency

X5-Adjustments of Prices, this was quantified by the change in percentage in commodity prices

due to foreign exchange change.

X6–Is the company size and was included as a control variable, it got estimated by assuming the

total assets Natural Log

ε –Term of error

The independent variables, in the study, including X1, X2, X3, X4, and X5, represent the

foreign exchange strategies of risk management. The variables got computed and operationalized

using the annual data collection between 2001 and 2018 across the financial organizations in the

African continent. The association between the independent variable gets analyzed in assisting in

developing multiple models of prediction, which exposes the relationship of non-existence

having the value of correlation as zero. If the correlation equals 1, it implies a perfect positive or

negative relationship. Therefore, there exists no relationship at zero points while there is an ideal

relationship at point 1. The research made use of the quoted amounts from the reports in every

strategy of foreign exchange risk management. Besides, the model strength got computed using

the t-test due to the small (20 companies) sample size of the study.

Variables Descriptions

Variables

Description

Measurement

Return on Asset Is the

ROA

This variable gets measured by the use of

ROA from banks, ratio. This ROA will be

useful in measuring the financial

performance

X1 represents the forward

contracts

Measurements of the forward contract were

observed using the relative change in ratio on

the fixed market value of the currency. This

information got generated by involving

participants to trade with a particular

currency amount at a defined rate on a

specific time in the future

X2 this represents the

cross-currency swap

This variable got quantified by the change in

ratio in currency value as a result of currency

exchange

X3 denotes the options

The measurements of Options were taken

using change in rate in premium. The

payments of the premium are made upfront

to prevent exposure to foreign exchange

X4 represents the leading

and lagging

This variable gets measured as the loss ratio

in depreciation as a result of changes in

foreign exchange

X5, It acts as price

Adjustments of prices get estimated as the

Africa and Risk Control 23

adjustments

change in price ratio of commodities brought

about by the changes in foreign exchange

The company size

It got obtained by adding

all the assets of a particular

organization

It is measured using the natural logarithm of

total assets held by the financial institution in

Africa

3.8 Diagnostics Tests

Before the performance of data analysis, specific diagnostics tests got performed. Testing

of assumptions is essential tasks while making use of multiple regressions. Serious omissions

result in low or high confident approximations, a biased relationship of the precision of the

coefficients, variable intervals of confidence, standard error as well as significance tests (El

Khawaga, Esam and Hammam 2013).

3.8.1 Normality

Descriptive statistics got utilized in checking for normality. This value represented

skewness and kurtosis of data distribution. Again, Jarque –Bera test proved useful in this stage.

Jarque-Bera has its basis on residuals of the least model of squares regression. Its value is usually

zero for normal distribution. The null hypothesis in this study is that the disturbances are

generally not dispersed. Therefore if the value of p is not higher than 0.05, then the normality

null at 5 percent level gets rejected.

3.8.2 Multicollinearity

The variance inflation factor was used to test the existence of a stable connection

amongst the independent variables. If the thumb rule on variance is more significant than ten

(10), then multicollinearity is an issue, and therefore, it needs investigation.

3.8.3 Heteroscedasticity

When the error variance is not constant, then it results in heteroscedasticity. On the other

hand, homoscedastic occurs when the residuals have a persistent variation. Hence, the variance

for every error term is independent and persistent of the descriptive variables. This research

made use of the white’s test in detecting heteroscedasticity. It investigates if the disturbance

variance gets influenced by any repressors’, their cross items or squares.

3.8.4 Autocorrelation

According to Folker, Schulman, and Baylies (2014, p.360), autocorrelation is the

correlation on a series of time when comparing the values of the past with the future over a

duration of time. In this study, the Durbin Watson test got used in the detection of

autocorrelation on the analysis of regression. According to Apuke (2017, p.41), failure in the

identification and accounting for serial correlation in the term of idiosyncratic error within a

panel model would cause a biased error of standard and inaccurate estimate of the parameters in

question. This test’s null hypothesis argues that the data contain no serial correlation. In cases

where there is a detection of serial correlation in the panel data, then, FGLS approximation will

get adopted.

Africa and Risk Control 24

3.8.5 Stationarity Tests

This test made use of the analysis of Augmented Dickey-Filler in testing stationarity.

However, non- stationarity does not exist when variance and mean are not constant in a time

series. Non- stationarity in the analysis of regression results to the unauthentic correlation. This

point raises the t-scores and R2 value of the non-stationary found in dependent variables

resulting in the specification of the correct model.

3.9 Ethical Consideration

An ethical consideration can get defined as the degree to which people apply ethical

principles and values consistently in varying issues of the environment. Scholars usually obey

this principle to attain a fair outcome (Berger 2018). This research made use of confidentiality

and informed consent. Adherence and application of the two aforementioned ethical

considerations enable the generation of unbiased answers from participants. The borrowing of

the works of other researchers in this study without their identity citation got avoided; otherwise,

this could cause plagiarism. This research cited the identity of authors whose works have got

used in aiding the completion of this study. All the citations adopted Harvard’s referencing style.

Africa and Risk Control 25

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