Exchange Rate Fluctuation and the Stock Return of Listed Multinational Companies in Sri Lanka

According to the availability of resources, countries make the choice between production, export, and import, and they usually attempt to gain competitive advantages through foreign trade activities. Thus, internationally active firms have to face the currency fluctuation risk frequently and disclose the foreign currency gains and losses during the year in their financial statements. Though the literature provides empirical evidence on the impact of exchange rate fluctuation on stock return in foreign countries, studies about the Sri Lankan context are limited. This study, following a quantitative research approach, investigates the relationship between the exchange rate fluctuation and the stock return based on secondary data from selected 31 listed multinational companies in Sri Lanka for the period from 2010 to 2020. ‘Exchange rate fluctuation’ and ‘stock return’ are measured using the change in the trade-weighted exchange rate, and stock prices plus dividends respectively. Market portfolio rate of return (MPRR) and inflation rate are used as control variables. By applying panel regression analysis, findings reveal a significant negative relationship between stock returns and trade-weighted exchange rate (TWER). However, control variables (MPRR and the inflation rate) show divergent results with the stock return. Accordingly, the market portfolio rate of return shows a significant positive relationship with the stock return. Contrary to MPRR, there is a significant negative relationship between inflation rate and stock return. Thus, as a fresh study conducted in the Sri Lankan context, these findings reveal that high variations in the exchange rate could lead to uncertain stock returns whereas increased exchange rates and inflations rates reduce firms’ market-based performance in terms of stock returns. These findings provide insights and directions towards introducing and regulating policies connected with the exchange rate to mitigate the abrupt impacts of exchange rate fluctuations on individual firms and the economy. Accordingly, the findings of this study would be beneficial for policymakers in taking policy decisions for promoting the international trade of the country while regulating exchange rate and monetary policies.


Introduction
A foreign exchange rate is a rate at which one currency can be converted into another currency (Ahmad, Rehman, & Raoof, 2010).
Businesses expect a steady change in these exchange rates as the abrupt changes in the exchange rate may cause a country's exports and imports to suffer (Ahmad et al., 2010).
Nevertheless, unexpected currency movements have become a major factor of macroeconomic uncertainty in determining profitability, stock return, and firm value of multinational companies (MNCs) due to the variations made to the cash flows (Muller & Verschoor, 2006).
However, these variations cannot be directly observed (Boudt, Neely, Sercu, & Wauters, 2019;Jorion, 1990). Accordingly, the researchers have segmented their studies based on the time variations and industry-specific factors to identify the impact of exchange rate fluctuations (Boudt et al., 2019).
The variations in exchange rates may affect firms that have engaged in exports and imports, licensed foreign subsidiaries, and established foreign subsidiaries (Aray & Gardeazabal, 2010). According to Hung (1997) In order to manage this exposure, the central bank of a country can intervene in the process of determining the exchange rate by using sophisticated financial measures (Biswal & Jain, 2019). The floating exchange rate is determined by the independent foreign exchange market demand and supply forces and it may subject the firms' foreign exposure to more volatility (Ramasamy & Abar, 2015). cash flows and when the domestic currency depreciates, the multinationals may earn more profits through sales and spend more on imports of production factors (Boudt, Neely, Sercu, & Wauters, 2019;Gao, 2000;Hung, 1997;Shapiro, 1975).
Exploring the impact of exchange rate fluctuations on stock return, some researchers stated that they were unable to identify the relationship between exchange rate fluctuations and stock return, and the reason may be the negligence of hedging activities and time instability (Crabb, 2002;Gao, 2000;Ihrig & Prior, 2005;Jorion, 1990;Muller & Verschoor, 2006). They concluded that there is no statistically significant relationship between exchange rate fluctuations and stock return (Jorion, 1990;Amihud, 1994;Bodnar and Gentry, 1993 as cited by Gao, 2000).
Therefore, this study attempts to explore the impact of exchange rate fluctuations on stock return regarding the Sri Lankan context. According to Shapiro (1975), the stock return of totally export-oriented firms will gradually decline in a period of high inflation. Hence, the inflation rate and market portfolio rate of return are used as the control variables in this study.

Review of Literature
Review of literature is presented relating to the following three major sections.

Exchange Rates
The exchange rate of a country can be identified in terms of the value paid by that country for goods, services, and finance during international trade activities (Rajakaruna, 2017). The Central Bank of a country is given the statutory powers to intervene in the process of managing exchange rates (Rajakaruna, 2017). Accordingly, the Central Bank intervenes in the process of managing the exchange rate to mobilize capital and savings to fill the resource gap and expand the investments (Rajakaruna, 2017). He further identified both favourable and unfavourable effects of these fluctuations, and found that appreciated currency may reduce the price levels of imports in the local market which leads to a reduction in the inflation rate and vice versa. Moreover, the country's outstanding debt value will be lower in an appreciated exchange rate, which will reduce the burden of repayment (Rajakaruna, 2017).
In contrast, the appreciated exchange rate may stimulate more imports and it may badly affect the balance of trade, discouraging the exporters because of the lowering domestic currency.
However, the variations in exchange rates are due to the variations in the inflation rate, interest rates, the balance of trade, net official interventions, remittances, and net foreign purchases (Rajakaruna, 2017).
Hence, this study measures the exchange rate fluctuations using trade-weighted exchange rates for the study period.

Exchange Rate and Stock Return
According to Gao (2000), the exchange rate fluctuations may influence the multinationals' cash flows and it leads to variations in stock return. Going multinational has a significant effect on stock return. It implies that though the firms are small in size, they can earn more from foreign trade activities (Qian, 2002).
There is a curvilinear relationship between multinationalism and stock return. The earlier attempt of going multinational is positively correlated with the stock return, and, after a point, further extension of foreign activities causes the decline of stock return (Qian, 2002 According to Hughen and Beyer (2015), there is a negative relationship between exchange rate fluctuation and stock return whereas Ahmad et al. (2010) found that there is a positive relationship between exchange rate and stock return. In contrast, 112 some researchers concluded that there is no statistically significant relationship between exchange rate fluctuations and stock return (Jorion, 1990;Amihud, 1994;Bodnar and Gentry, 1993 as cited by Gao, 2000). Referring to the Sri Lankan context, Wickremasinghe (2012) discovered that there is no statistically significant relationship between exchange rate fluctuation and stock prices in the long run and there is a statistically significant relationship between exchange rate fluctuation and stock prices in the short run with reference only to US dollar.

Stock Return, Inflation and Market portfolio rate of return (MPRR)
Ricardo's theory of comparative advantage states that the countries should specialize to produce and export goods and services where they can earn competitive advantages in terms of cost of production and opportunity costs (as cited by Bahmani-Oskooee, 1993 international trade with such differences in costs. According to Shapiro (1975), if the firms are engaged more in domestic industries than the industries affected by import competition, the inflation will be beneficial.
Also, if the firms are sole exporters, these firms' profitability will decline, and if the firms are highly affected by import competitiveness to gain local resources, the profitability will decline in these firms during a period of inflation (Shapiro, 1975).
Consequently, the inflation rate is selected as According to Jorion (1990), marketadjusted betas are taken in order to mitigate the market risks. The findings of Bartov, Bodnar, and Kaul (1996)  of production (Shapiro, 1975

Research objectives
The main objective of this paper is to explore the impact of exchange rate fluctuations on stock return with special reference to listed multinational companies in Sri Lanka.

Research Methodology
This study applies quantitative research approach and the research design employed is descriptive.

Population, sampling and sample
The

Data collection and analysis methods
The data were collected only from secondary sources using audited annual reports and The dependent variable is the stock return, and it is measured using stock prices and dividends (Bartov, Bodnar, &Kaul, 1996;Gao, 2000;Ihrig & Prior, 2005;Jorion, 1990;Muller & Verschoor, 2006). In this study, the stock return is calculated using the following formula.

Descriptive Statistics
Descriptive statistics shown in Table 1

Panel Regression Results
The secondary data captured for the period of 10 years from 2010 to 2020 is analyzed using fixed panel regression results to assess whether exchange rate fluctuations affect stock returns.
The panel regression results are shown as follows.

Coefficient results and discussion
The coefficients   (Jorion, 1990;Amihud, 1994;Bodnar and Gentry, 1993 as cited by Gao, 2000), the current study found a statistically significant negative relationship between stock returns and trade-weighted exchange rate.
Accordingly, study results confirm the previous research findings that revealed a significant negative relationship between trade-weighted exchange rate and stock return according to the stock-oriented model (Boudt et al., 2019;Gao, 2000;Hung, 1997;Shapiro, 1975;Hughen and Beyer (2015).

Conclusions
In

Future Researchers
The stock return is one of the most significant market-based performance measurements that firms focus on. However, it might be affected by many micro and macroeconomic factors. due to the inconvenience of collecting data from all these multinational companies.
Therefore, it will be more worthwhile if future researchers explore the same area of concern focusing on almost all the multinational companies operating in Sri Lanka.