Essay: Why derivatives used as risk management tools

Essay: Why derivatives used as risk management tools
April 13, 2011 Comments Off on Essay: Why derivatives used as risk management tools Academic Papers on Business Studies,Sample Academic Papers admin

Sample Essay

Most of the nonfinancial firms use derivatives for different purposes like hedging and speculation etc. It is evident from the previous studies that the most important motive for using derivative is to reduce different financial risks. It is also to found that firms having huge cross-country sales are extensively using the derivatives. While the companies that used interest rates derivatives have a higher level of financial leverage in their capital structures. [1]

They also proved from their study on the global firms that derivative using firms have significantly reduced their risks as compared to the firms which normally don’t use the derivative. The stocks variation in the returns of these firms is also significantly less than the other non-users firms[2]. Allayannis and Ofek found that most of the non-financial firms, whose stocks are traded on S&P-500, have reduced their exchange rate risk by properly using cross currency derivatives[3]. He found that firms that use derivatives have low risk which is measured by their stock price volatility as compared to those which don’t use derivatives.[4] Brown and Toft also found that most of the firms using derivatives have the hedging motive rather than speculative one[5].

Dolde concluded from his research that firms which are large in size and have a global presence are using derivatives heavily than those which are confined to one county[6]. Nance & Smithson studied the US’s firms mainly non-financial found that majority (62%) of the sample firms use derivatives for hedging purpose[7]. Main also studied US firms but its sample size was much bigger (3022 firms) than that of Nance & Smithson (169 firms)[8]. He reported that the firms which are using all types of the derivative are 26%, only 15% use currency and same percentage is using interest rates derivatives[9].

[1] Bartram, S. M., and G. W. Brown and F.R. Fehle. “International evidence of financial derivatives usage.” University of South Carolina, 2003.

[2] Ibid

[3] (Allayannis, G., and E. Ofek. “Exchange rate exposure, hedging, and the use of foreign currency derivatives.” Journal of International Money and Finance, 2001: 273-96.

[4] ibid

[5] Brown, G. W., and K. B. Toft. ” How firms should hedge.” Review of Financial Studies, 2002: 283-324.

[6] Dolde, W. “The trajectory of corporate financial risk-management .” Journal of Applied Corporate Finance, 1993: 33-41.

[7] Nance, D. R., and C. W. Smith & C. W. Smithson. “On the Determinants of Corporate Hedging.” Journal of Finance, 1993: 267-284.

[8] Mian, S. L. ” Evidence on corporate hedging policy.” Journal of Financial and Quantitative, (1996), : 419-39.

[9] ibid

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