TABLE OF CONTENTS

DECLARATION ii

LIST OF ABBREVIATIONS iii

CHAPTER ONE: INTRODUCTION 1

1.1 Background 1

1.1.1 Derivatives 2

1.1.2 Foreign Currency Exposure of a Commercial Bank 3

1.1.3 Effect of derivatives on foreign exchange exposure 5

1.1.4 Commercial Banks in Kenya 6

1.2 Research Problem 7

1.3 Objectives of the Study 8

1.4 Value of the Study 9

CHAPTER TWO: LITERATURE REVIEW 10

2.1 Introduction 10

2.2 Theoretical review 10

2.3 Foreign Exchange Risk Management 13

2.6 Empirical Review 18

2.6 Summary of Literature review 19

CHAPTER THREE: RESEARCH METHODOLOGY 20

3.1 Introduction 20

3.2 Research Design 20

3.3 Study Population 20

3.4 Data Collection Procedures 20

3.5 Data Analysis and Presentation 20

REFERENCES 22

APPENDICES 26

LIST OF ABBREVIATIONS

CBK – Central Bank of Kenya
ERV - Exchange rate volatility
FOREX – Foreign Exchange
FX – Foreign Exchange
IFE – International Fisher Effect
IFX - Income from foreign currencies as a percentage of total income
IRP – Interest Rate Parity
MST – Market Segmentation Theory
NA - Net Assets
NFXNA - Net Foreign Currency Exposure Relative to Net Assets
NFX - Net Foreign Currency Exposure
NSE – Nairobi Securities Exchange
OS - Ownership Status or Nature of Ownership
PPP – Purchasing Power Parity

CHAPTER ONE: INTRODUCTION

1.1 Background

The traditional role for commercial banks has been perceived to be the reduction of transactions costs and the provision of information. However, given the technological, information, and financial innovations of the last decade, risk sharing and risk management are increasingly being viewed as a major source of value creation in banking. Allen and Santomero (1997) argue that these changes have increasingly shifted banks away from their traditional