Using a unique dataset of East Asian non-financial companies, this paper examines a firm's choice between local currency, foreign currency, and synthetic local currency (hedged foreign currency) debt. We also exploit the Asian financial crisis of 1997 as a natural experiment to investigate the role of debt type in financial and operating performance. We find evidence of unique, as well as common, factors that determine each debt type's use thus indicating the importance of examining debt at a disaggregated level. Specifically, the use of natural local currency debt is associated primarily with factors found by many other studies to determine total debt levels such as size, profitability, and the market-to-book ratio. Foreign currency debt is used as a complement to local currency debt by firms with substantial capital needs seeking to lower the cost or extend the maturity structure of debt. However, the use of foreign currency debt is also determined by asset and income type consistent with agency cost and financial risk management theories. The use of synthetic local debt is primarily determined by risk management concerns. Finally, contrary to anecdotal reports and existing theory, we find no evidence that unhedged foreign currency debt is associated with significantly worse performance during the Asian crisis. Surprisingly, the use of synthetic local currency debt is associated with the biggest drop in market value, possibly due to currency derivative market illiquidity during the crisis.

This paper examines whether firms are hedging or timing the market when selecting the interest rate exposure of their new debt issuances. I use a more accurate measure of the interest rate exposure chosen by firms by combining the initial exposure of newly issued debt securities with their use of interest rate swaps. The results indicate that the final interest rate exposure is largely driven by the slope of the yield curve at the time the debt is issued. These results suggest that interest rate risk management practices are primarily driven by speculation or myopia, not hedging considerations.

This paper examines the use of credit derivatives by US bank holding companies from 1999 to 2003 with assets in excess of one billion dollars. Using the Federal Reserve Bank of Chicago Bank Holding Company Database, we find that in 2003 only 19 large banks out of 345 use credit derivatives. Though few banks use credit derivatives, the assets of these banks represent on average two thirds of the assets of bank holding companies with assets in excess of $1 billion. Few banks are net buyers of credit protection and disclose using credit derivatives to hedge loans. Banks are more likely to be net protection buyers if they engage in asset securitization, originate foreign loans, and have lower capital ratios. The likelihood of a bank being a net protection buyer is positively related to the percentage of commercial and industrial loans in a bank’s loan portfolio and negatively or not related to other types of bank loans. The use of credit derivatives by banks is limited because adverse selection and moral hazard problems make the market for credit derivatives illiquid for the typical credit exposures of banks.

participants at the annual meetings of APFA and the German Finance Association, especially our discussant Tjalling von der Goot. We also thank participants of the finance workshops at the

the Hong Kong Research Grants Council for their comments and suggestions. We are also grateful to Ted Reeve for providing us with his derivative surveys of gold mining firms. The Research Grants Council of Hong Kong provided financial support for this project, and Harry Kam Ming Leung provided excellent research assistance. We claim responsibility for any remaining errors. Hedging, speculation and shareholder value We examine the common hypothesis in the risk management literature, that derivatives transactions have zero intrinsic net worth, and add value only because they help firms mitigate market imperfections by hedging financial risk. For a sample of 92 North American gold mining firms we infer the quarterly cash flows that each firm derives specifically from its derivatives transactions. We find that these derivatives cash flows are significantly positive on average, both economically and statistically, irrespective of the direction of gold prices. These positive derivatives cash flows appear to translate into increases in shareholder value, since we find no evidence of an upward adjustment of firms ’ systematic risk to offset the cash flow gains. The bulk of the gains appear to be the result of a persistent positive risk premium in the gold derivatives market. Consistent with anecdotal evidence on selective hedging, we find

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The recent East Asian (EA) financial crisis provides a natural experiment for investigating foreign-exchange risk management by non-financial corporations. During this period, the financial crisis exposed local firms to large depreciations in exchange rates and decreased access to foreign capital. We explore the exchange rate hedging practices of firms that hedge foreign debt exposure in eight EA countries between 1996 and 1998. Our paper makes three primary contributions. First, we identify and characterize EA companies that use foreign currency derivatives. This includes documenting differences in size, domestic and foreign debt exposures, and financial characteristics. Second, we investigate the factors important in the use of foreign currency derivatives. In contrast to studies of US firms, we find limited support for existing theories of optimal hedging. Instead, we find that firms use foreign earnings as a substitute for hedging with derivatives and evidence that EA firms engage in "selective" hedging. Third, we investigate the relative performance of hedgers during and after the crisis. We find no evidence that EA firms eliminate their foreign exchange exposure by using derivatives. More specifically, firms using derivatives prior to the crisis perform just as poorly as nonhedgers during the crisis. Post-crisis, firms that hedged performed somewhat better than nonhedgers, but this result appears to be explained by a larger post-crisis currency exposure for hedgers (an exchange rate risk premium), due to limited access to derivatives during that period.

This paper analyzes the wealth and risk incentive effects of managerial options and shareholdings on the hedging probability of UK listed Alternative Investment Market (AIM) companies. We find that the wealth incentive effect provided by managerial option holdings increases the hedging likelihood. On the contrary, the wealth incentive effect provided by managerial shareholdings decreases the hedging likelihood. Further tests show that the incentive effect provided by managerial shareholdings is significantly different if managers are not substantial shareholders of the company. Managers with substantial ownership are significantly less risk averse. Thus, the size and ownership structure characteristics of AIM companies seem to result in similarities between managers ‟ and owners ‟ behavior. JEL classification: G32; G34. 2

We delineate the impact of derivatives trading on asset risk for Canadian banks over the period starting 1997 till the fallout of the bank crisis in 2007. In light of the remarkable resilience of Canadian banks in dodging the current financial turmoil, we investigate whether such bank stability is attributable to effective risk management through derivatives use. After imputing asset risk from bank stock prices based on the option-theoretic model of Merton (1974), we ascertain the links between the implied asset risk and derivatives use for trading and hedging purposes. Our findings reveal that not only bank risk increases with trading in derivatives, but increases also with derivatives reportedly used for hedging. This puzzling evidence is robust to different model specifications and alternative methods of estimations. Our new evidence is important in two ways. First, it casts doubt on the effectiveness of hedge accounting. Second, it shows that the use of derivatives by Canadian banks does not explain their envied soundness. We therefore conclude that prudent practices limiting original risk exposures remain fundamental for safeguarding a healthy financial system. This lesson from Canada is particularly relevant for China, given its developing financial infrastructure and extreme reliance on banks in providing financing to its economy.

We contribute to the previous literature on the use of derivatives by studying separately the determinants for profit seeking versus hedging in a sample of firms from four different Nordic countries. While the hedging motive clearly dominates, more than half of the firms in our sample give some weight for additional income as a motive for the use of derivatives. Combining survey data on the use of derivatives with financial variables, data on management and blockholder ownership, as well as data on firm level diversification, we find that very different determinants drive the use of derivatives for these two motives. Firm level diversification is negatively related to hedging, but positively to the use of derivatives for additional income. Financial firms use derivatives more for profit than for hedging. KEYWORDS: