Relationship Between Foreign Exchange Risk and Profitability of Oil Companies Listed in the Nairobi Securities Exchange

Abstract

Firms are exposed to Foreign Exchange Risk if the results of their projects depend on future exchange rates and if exchange rate changes cannot be fully anticipated it can lead to major financial losses. This research has examined the influence of foreign exchange risk on the profits of oil companies listed in the Nairobi Securities exchange namely; KenolKobil and Total Kenya ltd. The objective of the study was to examine the relationship between how foreign exchange risk and profitability of oil companies listed in the Nairobi securities exchange. Using descriptive analysis, correlation and regression analysis, research results indicated that the foreign exchange risk greatly influences the profits reported by these oil companies. Other variables "namely the gross profit and operational expenses were used as predictors of profitability along with the foreign exchange risk and were also found to have a strong correlation to the profits. Foreign exchange risk as measures by the foreign exchange gain/loss reported by these companies was found to carry more weight in predicting the profitability of these two companies with a correlation coefficient of 95% Since it was evident that foreign exchange risk greatly affects the profits, It was recommended that the firm should develop a robust foreign exchange risk management framework which clearly shows their currency risk assessment Procedure and implementation of currency risk management strategies. The firm should also emphasize the use of currency risk transfer strategies through hedging, insuring and diversification of foreign exchange risk as management strategies in order to cushion their profits from getting negatively affected by the foreign exchange fluctuations as seen in both companies where KenolKobil recorded a loss after tax of 6.2 billion Shillings in 2012 out of which 4.6 Billion was comprised of foreign exchange losses whereas Total Kenya Ltd recorded a loss of202 Million shillings after tax and 81 million out of this was due to foreign exchange losses.