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The additional cost of hedging in foreign currency loans

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Listed:
  • Viet Do
  • Tram Vu

Abstract

Foreign currency denominated loans ( FCDLs ) are an important part of corporate funding as well as an operational risk management tool. We show that domestic borrowers use FCDLs to hedge their foreign exchange risk exposure. FCDLs are found to carry an interest rate premium over domestic currency loans after controlling for borrower characteristics, loan characteristics, and macroeconomic conditions. We argue that borrowers are willing to pay this premium since the marginal benefit of FCDLs as a natural hedge outweighs the marginal cost. From a lender’s perspective, this premium reflects a compensation for additional foreign exchange risk exposure and intensified monitoring efforts. These results are robust to endogeneity-corrected estimations. JEL Classification: G21, G32

Suggested Citation

  • Viet Do & Tram Vu, 2018. "The additional cost of hedging in foreign currency loans," Australian Journal of Management, Australian School of Business, vol. 43(2), pages 305-327, May.
    • Handle: RePEc:sae:ausman:v:43:y:2018:i:2:p:305-327
    DOI: 10.1177/0312896217726836
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    References listed on IDEAS

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    More about this item

    Keywords

    Cost of debt; currency choice; foreign currency denominated loan; hedging; interest rate arbitrage;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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