Corporate Hedging of Exchange Risk When Foreign Currency Cash Flow Is Uncertain
Management Science · 1995 · Volume 41 · Issue 6
Abstract
We analyze hedging policies for a corporation that generates a foreign currency cash flow that is not known with certainty. We obtain an intriguing result that the probability of bankruptcy for a firm that attempts to minimize this probability is lower when there is some uncertainty in the exchange rates than when there is no uncertainty in the exchange rates: the firm reduces the probability of bankruptcy by borrowing more than its financing needs through foreign currency borrowing alone and by investing the excess funds in domestic risk-free securities.
Keywords
hedging, exchange risk, corporate risk management, inflation uncertainty
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