Is Foreign Currency Denominated Debt a Hedging Instrument?

Abstract

We examine the role of foreign currency denominated debt in firms' risk management activities. In a sample of large US firms, we find a strong relation between aggregate foreign exchange exposure and foreign currency denominated debt. This relationship between exposure and foreign currency denominated debt also holds at the individual currency level. Firms' choice of denominating debt in Australian Dollar, Canadian Dollar, French Franc, German Mark, Italian Lira and British Pound is related to their exposure in these currencies. However, firms' choice of denominating debt in Swiss Franc and Japanese Yen is influenced not by exposure in these currencies, but by the high liquidity offered by the debt markets in these currencies. The evidence also suggests that creditor rights and information asymmetries influence choice of currency of debt. However, we find no evidence in favor of tax arbitrage induced currency preferences in the denomination of debt.