Foreign Currency Derivatives versus Foreign Currency Debt and the Hedging Premium

Abstract

This paper compares the effect on firm value of different foreign currency (FC) financial hedging strategies identified by type of exposure (short-or long-term) and type of instrument (forwards, options, swaps and foreign currency debt). We find that hedging instruments depend on the type of exposure. Short-term instruments such as FC forwards and/or options are used to hedge short-term exposure generated from export activity while FC debt and FC swaps into foreign currency (but not into domestic currency) are used to hedge long-term exposure arising from assets located in foreign locations. Our results relating to the value effects of foreign currency hedging indicate that foreign currency derivatives use increases firm value but there is no hedging premium associated with foreign currency debt hedging, except when combined with foreign currency derivatives. Taken individually, FC swaps generate more value than short-term derivatives.

Foreign Currency Debt Financing, Firm Value, and Risk: Evidence from Korea Surrounding the Global Financial Crisis

“…() show that FC debt hedged through currency derivatives for firms in emerging markets in Asia hurts their operating and financial performances due to the underdeveloped derivatives markets in these countries. Similarly, Clark and Judge () find that the reason for failing to relate FC debt to an increase in firm value is due to many constraints accompanying the management of foreign exchange risk using FC debt. Overall, the results of our paper suggest that while a firm's proper usage of currency derivatives in conjunction with FC debt helps reduce the firm's exchange rate exposure, as Geczy et al .…”

“…He further shows that firms participating in the international debt markets reveal more pronounced negative effects. In a study of United Kingdom firms, Clark and Judge () do not find conclusive evidence on the positive effect of FC debt on firm value. They note that this inconclusive evidence is mainly due to many constraints accompanying the management of foreign exchange risk using FC debt.…”

“…() refer to the underdeveloped derivatives markets in the Asian countries as the main reason that the usage of FC debt hedged through currency derivatives for firms in these emerging markets deteriorates their operating and financial performances. In a similar context, Clark and Judge () also attribute the reason for failing to relate FC debt financing to an increase in firm value to many constraints that hinder the effective management of foreign exchange risk using FC debt.…”

Foreign Debt Usage in Non‐Financial Firms: a Horse Race between Operating and Accounting Exposure Hedging

“…Based on a survey of US and Canadian non‐financial firms including both small and large firms and both listed and non‐listed firms, Graham and Harvey () find that a popular reason for issuing foreign debt is to provide a natural hedge against foreign currency devaluation. The hedging rationale is supported in an international context (e.g., Keloharju and Niskanen, ; Aabo, ; Clark and Judge, ). Three studies suggest that foreign debt usage is positively linked to physical presence abroad.…”

Foreign-currency bonds: currency choice and the role of uncovered and covered interest parity

“…Aabo (2006) also supports the notion that foreign-currency debt and derivatives are alternative hedging strategies. Finally, Clark & Judge (2008) provide evidence suggesting that foreign currency debt (hedging long-term cash-flows) complements foreign currency forwards and options (short-term hedging), but swaps used to create synthetic foreign currency debt are used as substitutes for issuing actual foreign currency debt.…”