Abstract

Derivatives are mostly used by corporations to hedge their foreign exchange or interest rate risk, especially in Asian countries due to their highly volatile political and economic situation. Current study aimed to determine the factors affecting firms hedging policies of both foreign currency and interest rate derivative instruments of 105 non-financial firms listed on Karachi Stock Exchange for the period of 2004-2008. Logit model was used to test whether the firm’s decision to use hedging instruments can increase firm value? For a detailed analysis, firm’s endogenous policies were regressed separately to identify the effect of firm’s investment and financing policies on firm’s hedging policies. The estimated results supported the financial distress hypothesis, tax convexity, underinvestment hypothesis and managerial risk aversion hypothesis. Though, inconsistent with the theory, interest coverage ratio demonstrated positive effect on firms hedging policies that may be attributed to the lag period effect.

Key words: Derivatives, hedging, foreign exchange derivatives, interest rate derivatives, Pakistan.