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Diversification of Portfolios

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In 1999, the Euro is introduced as a common currency used among Europe countries. It’ s a hypothesis that a common currency could reduce transaction costs and exchange rate risk. (Jurgen Schremp, Newsweek Special Issue 9/1998-2/1999) It’ s because the trade across countries avoiding the dealing ο f foreign currencies, then both ο f traders do not suffer the unexpected foreign exchange rate changes. The transaction cost occurred during the dealing ο f foreign currencies is eliminated as well. Then the relationship between foreign exchange rate and firm value could be observed through examining the effect ο f Euro on firms to check whether this hypothesis is feasible. In order to do so, there are three points need to be proved: After launching ο f Euro, for many countries, stock market volatility increases.

Compared to non-Euro countries and outside ο f Europe, those firms within the Euro area due to higher exposure ο f Euro currency may experience a lower increase. The introduction ο f Euro leads to the reduction ο f market risk, no matter this country is located in or outside ο f Europe. This point may testify that the nature ο f foreign exchange rate is non-diversifiable. Even though incremental foreign exchange rate exposures appeared in some firms, actually net absolute decreasing foreign exchange rate happened in the left 90% firms.

Then Euro could be stated have an impact on foreign exchange rate exposure, because it arose the reduction ο f foreign exchange rate exposure. Excluding the above 3 points, the market beta and foreign exchange rate beta ο f multinationals are turned out to be determined by the firm’ s characteristics, which refers to total sales, and foreign sales take place in Europe. Then the foreign exchange rate exposure reduced significantly for those multinationals with low total sales, but high foreign sales in Europe.

In addition, geography and industry competition is relevant to foreign exchange rate beta as well. Compared to non-Euro Europe, market beta and foreign exchange rate beta in the Euro area changed obviously larger because ο f the high exposure ο f Euro currency.

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