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Abstract:
We use a real options approach to evaluate the performance of proxy variables for a firm¿s investment opportunity set. The results show that on a relative scale, the market-to-book assets ratio outperforms all other proxy variables that we investigate. It has the highest information content with respect to investment opportunities, and it is least affected by other factors. Although both the market-to-book equity and the earnings-price ratios are related to investment opportunities, they do not contain information that is not already contained in the market-to-book assets ratio. Consistent with this finding, a common factor constructed from several proxy variables does not improve the performance of the market-to-book assets ratio.

Proxy variables, investment opportunity set, growth opportunities, real options, market-to-book ratios, mining industry, financial constraints

Abstract:
We document that firms in the gold mining industry have consistently realized economically significant cash flow gains from their derivatives transactions. We conclude that these cash flows have increased shareholder value since there is no evidence of an offsetting adjustment in firms' systematic risk. This finding contradicts a central assumption in the risk management literature, that derivatives transactions have zero net present value, and highlights an important motive for firms to use derivatives that the literature has hitherto ignored. Although we find considerable evidence of selective hedging in our sample, the cash flow gains from selective hedging appear to be small at best.

Corporate risk management, hedging, speculation, risk premium, hedging benefits

Abstract:
We document that firms in the gold mining industry have consistently realized economically significant cash flow gains from their derivatives transactions. We conclude that these cash flows have increased shareholder value since there is no evidence of an offsetting adjustment in firms' systematic risk. This finding contradicts a central assumption in the risk management literature, that derivatives transactions have zero NPV, and highlights an important motive for firms to use derivatives that the literature has hitherto ignored. We find considerable evidence of selective hedging in our sample, but the cash flow gains from selective hedging are small at best.

corporate risk management, speculation, risk premium, forward premium, selective hedging

Abstract:
This study investigates if the use of derivatives by corporations is likely to affect their financing strategies. I find a strong positive relation between the minimum revenue guaranteed by hedging and investment expenditures. This result implies that hedging increases the likelihood that investments can be financed internally. I also find that firms tend to finance their investment expenditures externally rather than internally. If external capital is more costly than internal capital it would clearly be in a firm's interest to reduce its dependence on external capital. Consistent with this result, I find that the median firm that does not hedge finances 100% of its investment expenditures externally, while the median firm that hedges finances only 86% of investments externally.

Abstract:
We analyze the hedging decisions of firms, which take into account both the costs and the benefits of risk, in an equilibrium context. The equilibrium setting allows us to examine how a firm's hedging choice depends on the hedging choices of its competitors. We show that in equilibrium some firms hedge, while others do not, even though all firms are ex ante identical. The model further shows how the fraction of firms that hedge depends on industry characteristics, such as on the number of firms in the industry, the elasticity of demand, the convexity of production costs, and the relative market shares of each firm. Consistent with prior empirical findings the model predicts that we should observe more heterogeneity in the decision to hedge in the most competitive industries.

Financial constraints, hedging, speculating, equilibrium, competition

Abstract:
The literature on corporate risk management has traditionally assumed that derivative securities are fairly priced, and thus disregarded the possibility that non-financial firms might use derivatives to generate positive returns by exploiting market conditions. This premise has led researchers to rationalize corporate risk management by its beneficial effects on bankruptcy costs and taxes, debt capacity, cost of capital, underinvestment costs, and managerial risk aversion. Our study questions this fundamental premise and thereby makes two principal contributions.

First, we show that the assumption that derivatives contracts are fairly priced on average can be violated for an extended period. By studying the hedging activities of a sample of North American gold mining companies over the 1989-1999 period, we find that these firms generated significant excess cash flows by selling gold forward. Our sample firms realized an average total cash flow gain of $11 million or $24 per ounce of gold per year, while their average annual net income was only $3.5 million. The source of these gains is a persistently positive spread between contracted forward prices and realized spot prices. This finding highlights a new motive for the corporate use of derivatives and a new potential source of value associated with risk management that the literature has previously ignored.

Second, and in contrast to our first contribution, we show that firms do not realize economically significant cash flow gains by trying to time the market in their use of derivatives. Market-timing in the context of hedging programs is a form of speculation. We find considerable evidence in our sample that managers respond to changing market prices by varying the sizes of their hedge positions, and that this variation is far in excess of what can be explained by changes in a firm's fundamentals. However, these attempts to time the market do not yield positive cash flows on average. We conclude that managers in our study have no market-timing ability and speculating in this way creates no value (and probably destroys value) for shareholders. This finding is in stark contrast to a widely-held view among many corporate executives that market timing should be an integral part of any hedging program.

Corporate risk management, speculation, risk premium, hedging benefits

Abstract:
In this article, the authors summarize the findings of their recent study of the hedging activities of 92 North American gold mining companies during the period 1989-1999. The aim of the study was to answer two questions: (1) Did such hedging activities increase corporate cash flows? (2) And if yes, were such increases the result of managements ability to anticipate price movements when adjusting their hedge ratios? Although the author's answer to the first question is yes, their answer to the second is no.

More specifically, the authors concluded that:

- During the 1989-1999 period, the gold derivatives market was characterized by a persistent positive risk premium - that is, a positive spread between the forward price and the realized future spot price - that caused short forward positions to generate positive cash flows. The gold mining companies that hedged their future gold production realized an average total cash flow gain of $11 million, or $24 per ounce of gold hedged, per year, as compared to average annual net income of only $3.5 million. Because of the positive risk premium, short derivatives positions did not generate significant losses even during those subperiods of the study when the gold price increased.

- There was considerable volatility in corporate hedge ratios during the period of the study, which is consistent with managers incorporating market views into their hedging programs and attempting to time the market by hedging selectively. But after attempting to distinguish between derivatives activities designed to hedge and those designed to profit from a view, the authors conclude that corporate efforts to time the market through selective hedging were largely if not completely futile. In fact, the companies' adjustments of hedge ratios appeared to consistently lag instead of leading the market.

Abstract:
Firms use a variety of different strategies to manage financial risks. This is the case even among firms that face practically identical risk exposures, such as gold mining corporations. This paper develops a theoretical model to show that this diversity can be explained by differences in firms' credit risk premia. If the credit risk premium is relatively small, firms use linear or convex hedging strategies. If the credit risk premium is relatively large, firms use concave hedging strategies. Firms in between those two extremes use strategies that feature both convex and concave elements, e.g. collar strategies. The model replicates essentially all observed hedging strategies in the gold mining industry.

Corporate risk management, cost of capital, credit risk, default premium, financing strategies, hedging strategies, security design