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Corporate Hedging of Exchange Risk When Foreign Currency Cash Flow Is Uncertain

Author

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  • Bhagwan Chowdhry

    (Anderson Graduate School of Management at UCLA, 405 Hilgard Avenue, Los Angeles, California 90024-1481)

Abstract

We analyze hedging policies for a corporation that generates a foreign currency cash flow that is not known with certainty. We obtain an intriguing result that the probability of bankruptcy for a firm that attempts to minimize this probability is lower when there is some uncertainty in the exchange rates than when there is no uncertainty in the exchange rates: the firm reduces the probability of bankruptcy by borrowing more than its financing needs through foreign currency borrowing alone and by investing the excess funds in domestic risk-free securities.

Suggested Citation

  • Bhagwan Chowdhry, 1995. "Corporate Hedging of Exchange Risk When Foreign Currency Cash Flow Is Uncertain," Management Science, INFORMS, vol. 41(6), pages 1083-1090, June.
    • Handle: RePEc:inm:ormnsc:v:41:y:1995:i:6:p:1083-1090
    DOI: 10.1287/mnsc.41.6.1083
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    Cited by:

    1. Coutinho, João Ricardo Ribeiro & Sheng, Hsia Hua & Lora, Mayra Ivanoff, 2012. "The use of Fx derivatives and the cost of capital: Evidence of Brazilian companies," Emerging Markets Review, Elsevier, vol. 13(4), pages 411-423.
    2. Akron, Sagi, 2019. "The optimal derivative-based corporate hedging strategies under equity-linked managerial compensation," Emerging Markets Review, Elsevier, vol. 41(C).
    3. Blenman, Lloyd P., 2004. "Diversifying internationally: disentangling hedging, valuation and capital cost effects," Journal of Multinational Financial Management, Elsevier, vol. 14(2), pages 97-103, April.
    4. Korn, Olaf, 2009. "Hedging price risk when payment dates are uncertain," CFR Working Papers 07-14, University of Cologne, Centre for Financial Research (CFR).
    5. Pollock, Andrew C. & Macaulay, Alex & Onkal-Atay, Dilek & Wilkie-Thomson, Mary E., 1999. "Evaluating predictive performance of judgemental extrapolations from simulated currency series," European Journal of Operational Research, Elsevier, vol. 114(2), pages 281-293, April.
    6. Mohamed Rochdi Keffala, 2017. "Are Derivatives Implicated in the Recent Financial Crisis? Evidence from Banks in Emerging Countries," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 20(01), pages 1-41, March.
    7. Brown, Gregory W., 2001. "Managing foreign exchange risk with derivatives," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 401-448, May.
    8. Prockl, Günter, 2011. "Comment on supply chain risk management," Die Unternehmung - Swiss Journal of Business Research and Practice, Nomos Verlagsgesellschaft mbH & Co. KG, vol. 65(2), pages 193-196.
    9. Huffman, Stephen P. & Makar, Stephen D., 2004. "The effectiveness of currency-hedging techniques over multiple return horizons for foreign-denominated debt issuers," Journal of Multinational Financial Management, Elsevier, vol. 14(2), pages 105-115, April.
    10. Korn, Olaf & Merz, Alexander, 2016. "How to hedge if the payment date is uncertain?," CFR Working Papers 07-14 [rev.], University of Cologne, Centre for Financial Research (CFR).
    11. Kristine Watson Hankins, 2011. "How Do Financial Firms Manage Risk? Unraveling the Interaction of Financial and Operational Hedging," Management Science, INFORMS, vol. 57(12), pages 2197-2212, December.
    12. Augusto Castillo R. & Rafael Aguila, 2005. "Estrategias Optimas De Cobertura En Presencia De Incertidumbre En Costos Y Cantidad," Abante, Escuela de Administracion. Pontificia Universidad Católica de Chile., vol. 8(2), pages 88-110.
    13. Olaf Korn & Alexander Merz, 2019. "How to hedge if the payment date is uncertain?," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 39(4), pages 481-498, April.

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