Ebook Corporate Interest Rate Risk Management With Derivatives In Australia: Empirical Results
The relative importance of corporate interest-rate-risk management has been analysed by previous studies in the United States and in Australia. Bodnaret al. (1998 [9]) show the results from a survey of financial risk management by U.S. non-financial firms. About 50% of the firms in the survey state that they use derivatives. Among derivative users, 83% use derivatives to hedge for eign exchange risk, 76% use derivatives to hedge interest rate risk and 56% use derivatives to hedge commodity price risk. Therefore, the survey indicates that corporate foreign-exchange-risk hedging in the United States is relatively more important. However, a survey by Benson and Oliver (2004 [4]) shows that interest-rate-risk hedging is relatively more important to non-financial compa nies in Australia. In their survey, 76% of the respondents use derivatives. Among the respondents, 63% use derivatives to hedge interest rate risk, 58% use deriva tives to hedge foreign exchange risk and 29% use derivatives to hedge commodity price risk. In fact, the relative greater importance of interest rate risk in Aus tralia must be one of the reasons why Australian accounting standards require companies to report this risk with more detail.
Bartram (2001 [2]) points out the importance of interest rate risk management for non-financial corporations. He argues that interest rate risk has direct eects on financial assets and liabilities but that there are also indirect eects on the value of real assets and projects. However, the fact that non-financial firms have a larger proportion of non financial assets in their balance sheets makes it more difficult for them to match financial assets and liabilities, in order to achieve complete immunization. Therefore, this study recognises the importance of the interest rate risk management of non-financial companies through the risk control of interest-rate-bearing liabilities.
This paper analyzes the corporate demand for interestrate-risk management in Australia.We show that previous studies have faced data limitations in order to measure relevant variables. For example, due to limitations in the information available in financial reporting, most previous studies were not able to quantify firms’ financial risk exposures. In consequence, the usual dependent variable used to measure the extent of financial hedging is the ratio of principal notional amount of derivatives to firm size. Most previous studies explicitly recognise the limitations of using this variable, but no better variable was available under the accounting standards in force at the time the data was generated. Therefore, this study builds on previous studies in the sense that it is able to measure the interest-rate-risk exposures of non-financial Australian companies.
Since 1997 Australian accounting standards require detailed reporting of companies’ interest-rate-risk exposures.According to the reporting rules in force since 1997, Australian companies are required to report the value of interest-rate-risk exposures and the extent to which these exposures are hedged with derivative financial instruments. Therefore, a manual collection of this detailed information makes it possible to measure the extent of interest-rate risk hedging with the ratio of principal notional amount of derivatives to total interest-rate-risk-bearing liabilities. As far as we are aware, this is the first empirical study to measure the risk exposure of corporate interest-rate-risk bearing liabilities. This has important implications to the empirical results, as shown in the following sections.
The two data sets used in this study cover respectively 1102 and 465 observations from 1998 to 2003. The first data set is used in a probit model to analyse the corporate decision to hedge interest rate risk. As in many previous studies, the binary dependent variable is equal to 1 if the company hedges with interest-rate derivatives and equal to 0 if otherwise. The empirical results are similar to those in previous studies, finding a significant importance of company size to the decision to hedge with derivatives. The second data set is used to analyse the extent of hedging. The analysis is done with different model specifications and by comparing the results of using two different dependent variables: 1) the ratio of principal notional amount of interest-rate derivatives to company size, which is the dependent variable used in previous studies; and 2) the ratio of principal notional amount of interest-rate derivatives to total interest-rate-risk-bearing liabilities.
The results show how some estimates are very different depending on the dependent variable used. For example, when the dependent variable is the ratio of principal notional amount of derivatives to company size the results show a significance of leverage, which is a common result in previous results using this dependent variable (for example, see Samant (1996 [46]). However, leverage is not significant if the dependent variable is the ratio of the principal notional amount of derivatives to interest-rate-risk-bearing liabilities. In this case, it is possible to notice the significant importance of the proportion of floating-interest-rate risk debt. Finally, the paper concludes that future research will benefit from more detailed hedging reporting due to the recent changes implemented by the International Financial Reporting System (IFRS), whose hedging reporting re quirements became operative in January 2005.
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