Managing Foreign Currency Risk with Derivatives: Evidence from UK Non-Financial Firms

Abstract

The paper reports the results of an empirical study into the foreign exchange risk management of large UK non-financial corporations. Using a sample of FT UK 500 non-financial firms for 1999, I examine the impact of currency derivatives on firm exchange-rate exposure, the factors that prompt corporations to hedge, and the factors that affect their decision on how much to hedge. I find a strong negative association between foreign currency derivative use and firm exchange-rate exposure, suggesting that firms use derivatives as a hedge rather than to speculate in the foreign exchange markets. The evidence also shows that a firm's currency exposure through foreign operations and import/export activity is a very important factor that prompts firms to hedge. And the size of the firm is positively related to the foreign currency hedging decision, indicating that larger firms are more likely to hedge than smaller firms.