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 andor 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. © 2007 Blackwell Publishing Ltd.