DOI: 10.36347/sjebm.2020.v07i10.002

Pages: 357-366

This paper examines, in an empirical setting, the effect of financial hedging on investment decisions by non-financial firms. Using the total notional values of currency, interest rate and commodity derivatives as a measure of financial hedging by non-financial S&P 500 firms for a period of 1996-2000, we find that financial hedging reduces the sensitivity of investments to cash flow for the sample firms. This result holds even after controlling for several other variables including debt ratio, Tobin’s Q, and size. We find that hedging increases debt capacity and also hedging reduces the cash flow variability thus reducing the probability of financial distress. Consistent with past studies, We also find that investment is significantly negatively correlated with leverage and significantly positively correlated to internal cash flow and firm size.