Why firms in the UK use interest rate derivatives

Abstract

Evidence reported by Geczy, Minton and Schrand (1997) showed that foreign exchange risk had a significant influence on the use of currency derivatives but that interest cover and financial leverage did not. In this study, we suggest that the reason why foreign exchange risk was significant but interest cover and financial leverage were not significant in the evidence was because currency derivatives were used to measure the dependent variable. We verify the validity of this suggestion by testing the influence of interest cover and financial leverage on the use of interest rate derivatives. Our sample comprises 140 firms in the UK, 48 of which use interest rate derivatives. Evidence observed shows that interest cover and financial leverage have a significant influence on the use of interest rate derivatives and that foreign exchange risk does not. We also compare the previous evidence referred to above with our results to determine whether there is a difference between the factors that motivate firms to use currency derivatives or interest rate derivatives. The result of the comparison indicates that dependence on overseas product and capital markets, tax, institutional shareholding and economies of scale are the factors that motivate firms to use currency derivatives. The result also indicates that high interest cover (i.e. interest/profit before interest and tax)or total debt ratio, economies of scale and directors’ shareholding are the factors that motivate firms to use interest rate derivatives.

Citation

Adedeji, A. and Baker, R. (2002), "Why firms in the UK use interest rate derivatives", Managerial Finance, Vol. 28 No. 11, pp. 53-74. https://doi.org/10.1108/03074350210768167