The Determinants of Foreign Currency Hedging: Does Foreign Currency Debt Induce a Bias?

In this paper we use UK data to present strong empirical evidence that explains the mixed results in previous studies with respect to the effect of financial distress on the demand for corporate hedging. We build on recent studies that have identified a strong link between foreign currency (FC) debt use and leverage. Given this relationship, we show that using leverage variables as proxies for financial distress and the failure to distinguish between FC debt users and non‐users causes misleading inference. More specifically, when we partition our sample of FC hedgers into firms that use and do not use foreign debt, we show that leverage variables are significantly related to the FC hedging decision for firms that use FC debt either in isolation or in combination with FC derivatives but not for firms that only use FC derivatives. This suggests that FC debt users are influencing these results. However, we also find that other financial distress cost proxies with no obvious link to FC debt use are significant determinants in the corporate demand for FC hedging, including derivatives use.     

Benefits from Asia-Pacific Mutual Fund Investments with Currency Hedging

This study presents empirical evidence on the efficiency and effectiveness of hedging U.S.-based international mutual funds with an Asia-Pacific investment objective. The case for active currency risk management is examined for a passive and a selective hedge, which is constructed with currency futures in the major currencies. Both static and dynamic hedging models are used to estimate the risk-minimizing hedge ratio. The results show that currency hedging improves the performance of internationally diversified mutual funds. Such hedging is beneficial even when based on prior optimal hedge ratios. Further, efficiency gains from hedging, as measured by the percent change in the Sharpe Index, are greatest under a selective portfolio strategy that is implemented with an optimal constant hedge ratio.     

The Impact of Institutional Differences on Derivatives Usage: a Comparative Study of US and Dutch Firms

This paper examines the influence of institutional differences on corporate risk management practices in the USA and the Netherlands. We compare results to surveys in each country using a strategy that corrects for differences over industry and size classes across the Dutch and US samples. We document several differences in the firms’ uses and attitudes towards derivatives and attempt to attribute them to the differences in the institutional environments between the USA and the Netherlands. We find that institutional differences appear to have an important impact on risk management practices and derivatives use across US and Dutch firms.     

Bank Funding,Securitization, and Loan Terms: Evidence from Foreign Currency Lending

We examine how bank funding structure and securitization activities affect the currency denomination of business loans. We analyze a unique data set that includes information on the requested and granted loan currency for 99,490 loans granted to 57,464 firms by a Bulgarian bank. Our findings document that foreign currency lending is at least partially driven by bank eagerness to match the currency structure of assets with that of liabilities. Our results also show that loan currency, as well as loan amount and maturity, are adjusted to make loans eligible for securitization.     

Managerial Stock Options and the Hedging Premium

Previous studies have found mixed evidence on whether hedging increases firm value. Some studies have shown that managerial incentives may influence firm hedging. In this paper we provide evidence that when hedging is based upon incentives from managers' options, firm value decreases.     

Exchange Rate Exposure,Foreign Currency Debt,and the Use of Derivatives: Evidence from Brazil

This paper studies the exchange rate exposure and its determinants for a sample of nonfinancial Brazilian companies from 1996 to 2006. The results indicate that the number of firms exposed to exchange rate fluctuations is higher in periods of crisis and under a fixed exchange rate regime. In addition, the results point out that, although companies' international activities, operational hedging, and financial policies are important determinants of firms' exposure, the changes in companies' exposure that took place when Brazil moved from a fixed to a floating exchange rate regime were mainly driven by changes in companies' foreign currency borrowing and the use of derivatives that occurred in that period.     

The Importance of Corporate Foreign Debt in Managing Exchange Rate Exposures in Non‐Financial Companies

This empirical study of the exchange rate exposure management of Danish non‐financial firms listed on the Copenhagen Stock Exchange shows that debt denominated in foreign currency (‘foreign debt’) is a very important alternative to the use of currency derivatives. The results show that the relative importance of foreign debt is positively related to (1) the extent of foreign subsidiaries, (2) the relative value of assets in place, and (3) the debt ratio. The pivotal role of time horizon is emphasised. These findings are important to firms in other countries with open economies.     

Distressed Debt Restructuring in the Presence of Credit Default Swaps

The availability of credit insurance via credit default swaps has been closely associated with the emergence of empty creditors. We empirically investigate this issue by looking at the debt restructurings (distressed exchanges and bankruptcy filings) of rated, nonfinancial U.S. companies over the period January 2007–June 2011. Using different proxies for the existence of insured creditors, we do not find evidence that the access to credit insurance favors bankruptcy over a debt workout. However, we document higher recovery prices following a distressed exchange in firms where empty creditors are more likely to emerge.     

Hedging,Financing and Investment Decisions: A Simultaneous Equations Framework

We empirically investigate the interactions among hedging, financing, and investment decisions. We argue that the way in which hedging affects a firm's financing and investing decisions differs for firms with different growth opportunities. We find that high growth firms increase their investment, but not leverage, by hedging. However, we also find that firms with few investment opportunities use derivatives to increase their leverage.     

Credit Risk Spreads in Local and Foreign Currencies

Governments, corporations, and even small firms raise and denominate capital in different currencies. We examine the micro‐level factors that should be considered by a borrower when structuring debt denominated in various currencies. This paper will show how the currency composition of debt affects the cost of debt through the interaction with the risk of company's assets. We look at the currency mismatch in the firm and analyze its credit spread within a Merton's type model with bankruptcy. We show that foreign currency borrowing is cheaper when the exchange rate is positively correlated with the return on the company's assets. The determining factor is not just whether a given company is an exporter or importer, but rather the statistical correlation between the rate of return on the firm's assets and changes in the exchange rate.     

Capital Structure Swaps and Shareholder Wealth

We show how capital structure swaps can increase the wealth of a firm's long‐term shareholders when a firm's debt or equity is misvalued. We review the conventional rule that a firm should issue equity and use the proceeds to retire outstanding debt (an equity‐for‐debt swap) when equity is overvalued, or repurchase equity with proceeds of new debt (a debt‐for‐equity swap) when equity is undervalued. We also analyse the more complex case where a firm's debt and equity are both undervalued, showing the optimal swap may be to issue undervalued equity, contrary to the conventional rule.     

Foreign Exchange Risk,Hedging, and Tax-Motivated Outbound Income Shifting

Although outbound income shifting to low-tax jurisdictions provides tax savings, it is often accompanied by nontax costs. In this study, I examine whether foreign exchange (FX) risk constrains tax-motivated outbound income shifting by U.S. multinational corporations. My findings indicate that exposure to greater currency volatility is associated with less outbound income shifting, and this effect is stronger for firms with foreign affiliates using foreign functional currencies. I also investigate whether hedging facilitates outbound income shifting. Consistent with hedging lowering costs associated with exchange rate volatility, I find that U.S. firms that use more currency derivatives tend to shift more income to low-tax foreign jurisdictions. Overall, these findings suggest that FX risk is an important cost of outbound income shifting.     

Short‐Term Corporate Debt around the World

Short‐term corporate debt as a proportion of total debt issued by public firms varies greatly across countries, between 28% in the United States and 78% in China. This paper argues that the interaction between information asymmetry and legal protection of creditors is an important determinant of debt maturity. When short‐term debt plays a dual role as signaling and commitment devices, a reduction in information asymmetry has a larger impact on debt maturity when creditor rights are weaker. We find empirical support for this prediction using firm‐level data from 45 countries around the world.     

Corporate Hedging Policy and Equity Mispricing

We show that firms’ use of derivatives is negatively associated with stock mispricing. This result is consistent with the notion that hedging improves the transparency and predictability of firms’ cash flows resulting in less misvaluation. Furthermore, we show that the negative relationship between mispricing and hedging is particularly strong when market value is below fundamental value, which is consistent with prior evidence that hedging has a positive impact on firm valuation. Finally, we provide evidence that a “spread‐out” hedging policy that entails the use of a variety of derivative contracts can be more effective in reducing mispricing.     

An Intertemporal International Asset Pricing Model: Theory and Empirical Evidence

We extend Campbell's (1993) model to develop an intertemporal international asset pricing model (IAPM). We show that the expected international asset return is determined by a weighted average of market risk, market hedging risk, exchange rate risk and exchange rate hedging risk. These weights sum up to one. Our model explicitly separates hedging against changes in the investment opportunity set from hedging against exchange rate changes as well as exchange rate risk from intertemporal hedging risk. A test of the conditional version of our intertemporal IAPM using a multivariate GARCH process supports the asset pricing model. We find that the exchange rate risk is important for pricing international equity returns and it is much more important than intertemporal hedging risk.     

Why and How UK Firms Hedge

This paper attempts to differentiate among the theories of hedging by using disclosures in the annual reports of 400 UK companies and data collected via a survey. I find, unlike many previous US studies, strong evidence linking the decision to hedge and the expected costs of financial distress. The tests show that this is mainly because my definition of hedging includes all hedgers and not just derivative users. However, when the tests employ the same hedging definition as previous US studies, financial distress cost factors still appear to be more important for this sample than samples of US firms. Therefore, a secondary explanation for the strong financial distress results might be due to differences in the bankruptcy codes in the two countries, which result in higher expected costs of financial distress for UK firms. The paper also examines the determinants of the choice of hedging method distinguishing between non‐derivative and derivatives hedging. My evidence shows that larger firms, firms with more cash, firms with a greater probability of financial distress, firms with exports or imports and firms with more short‐term debt are more likely to hedge with derivatives. Thus, differences in opportunities, in incentives for reducing risk and in the types of financial price exposure play an important role in how firms hedge their risks.     

Derivatives Usage in Emerging Markets Following the GFC: Evidence from the GCC Countries

In this article, we avail of International Accounting Standards IFRS 7 to investigate the usage and motivation of hedging by firms in the Gulf Cooperation Council (GCC) countries (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates). The results of our panel and cross-sectional data logistic regressions indicate a focus on foreign exchange exposure, interest rates risk, and commodity risk in this region. We find that the use of hedging instruments in this region is also influenced positively by the firm’s size and, to a lesser degree, positively by the firm’s gearing ratio and negatively by its propensity to growth. The level of activity, nevertheless, remains lower than is the case for firms globally.