Keywords: Derivatives, debt maturity, swaps, hedging
Abstract: We develop and test a simple model of a firm's
optimal debt maturity and its demand for interest rate swaps using
1994 data of over 4000 nonfinancial corporations. As in other models
of derivative use, ours predicts a systematic relationship between a
firm's swap position and the interest-sensitivity of its cash flow.
We test this by estimating the cross-sectional relationship between a
firm's swap position and: (1) the amount of short-term and
floating-rate debt in its capital structure; and (2) the
interest-sensitivity of its EBITD. We find strong evidence that firms
use swaps to hedge interest rate risk arising from debt obligations
but little evidence that they hedge interest rate risks from operating
income. Consistent with theories of swap use (Arak et al., 1988,
Wall, 1989, and Titman, 1992), our model also predicts that firms that
avoid using swaps because of "transactions costs" issue less
short-term debt than swap users, since the former are unable to hedge
the resulting interest rate risk. We find this to be the case.
Full paper (117 KB PDF)
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