Financial Derivatives by Firms and Essay

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S. firms. The ambiguity can therefore not be ignored.

The work of Gomez-Gonzalez et al. (2012) investigated whether the use of foreign currency derivatives have any effect on the market value of firms using evidence gathered from Colombia. Their results indicated that an increase in the level of hedging ultimately leads to a higher growth in the value of a firm. The use of financial derivates (hedging) is therefore indicated to have a positive impact on a firms' value.

The work of Clark and Mefteh (2010) investigated the relationship between foreign currency derivative usage and firm value using evidence gathered in France and found that the value effect of the financial derivative usage is about 1.5 times higher and was much significant with relatively larger exposure to depreciation while remaining insignificant for firms with lower levels of exposure. This implies that the effects of the hedging instruments depends on the type of exposure (whether short or long-term) as well as the type of instruments (options, forwards, foreign currency debt and swaps) as suggested by Clark and Judge (2009). The work of Clark and Judge (2009) indicated that indeed the effect of the hedging instruments depends on the type of exposure. Short-term instruments like FC forwards and options are employed to hedge short-term exposure that is generated from export activity and the FC debts as well as FC swaps (into foreign currency) are employed in hedging long-term exposure that arises from assets that are located in foreign lands.

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The work of Clark and Judge (2009) therefore concluded that the value effects of derivates (foreign currency derivatives) usage is an increase in firm value but no hedging premium is associated with the use of foreign currency debt hedging. On an individual basis, FC swaps were noted to generate more value than the short-term derivatives.

The work of Gonzalez, Lopez and Cunill (2011) investigated the idea of hedging with derivatives and the concept of value creation empirically using data from the insurance industry. Their work tool indicated that the hedging decision as well as volume are positively correlated with the firm size, leverage as well as interest rate exposure (as noted in the work of Clark and Mefteh (2010)).More importantly, their work indicated that firms that use derivatives have a higher rate of return on investment a relationship that suggested that hedging decision influences value creation.

The work of Bartram et al. (2011) indicated that the effect of derivative use on firm value is very positive but is more sensitive to endogeneity as well as omitted variable concerns .The work of Ameer (2009) confirmed this.

Conclusion

The literature suggests that hedging has a value adding effect on firms. The effect however depends on that the type of exposure (whether short or long-term) as well as the type of instruments (options, forwards, foreign currency….....

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