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Risk Management: Coordinating Corporate Investment and Financing Policies

Kenneth A. Froot, David S. Scharfstein and Jeremy C. Stein
The Journal of Finance
Vol. 48, No. 5 (Dec., 1993), pp. 1629-1658
Published by: Wiley for the American Finance Association
DOI: 10.2307/2329062
Stable URL: http://www.jstor.org/stable/2329062
Page Count: 30
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Abstract

This paper develops a general framework for analyzing corporate risk management policies. We begin by observing that if external sources of finance are more costly to corporations than internally generated funds, there will typically be a benefit to hedging: hedging adds value to the extent that it helps ensure that a corporation has sufficient internal funds available to take advantage of attractive investment opportunities. We then argue that this simple observation has wide ranging implications for the design of risk management strategies. We delineate how these strategies should depend on such factors as shocks to investment and financing opportunities. We also discuss exchange rate hedging strategies for multinationals, as well as strategies involving "nonlinear" instruments like options.

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