Australian Foreign Currency Loans: Hedging or Arbitrage?

Do, Viet; Vu, Tram

doi:10.2139/ssrn.2365087

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Australian Foreign Currency Loans: Hedging or Arbitrage?

2014 Financial Markets & Corporate Governance Conference

38 Pages Posted: 10 Dec 2013 Last revised: 7 Apr 2014

See all articles by Viet Do

Viet Do

Monash University - Department of Accounting; Financial Research Network (FIRN)

Tram Vu

Monash University - Monash Business School - Department of Banking and Finance

Date Written: March 30, 2013

Abstract

Foreign currency denominated loans (FCDLs) are an important part of corporate funding as well as an operational risk management tool. We show that Australian 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.

Keywords: foreign currency denominated loans, hedging, interest rate arbitrage, currency choice, loan prices

JEL Classification: G21, G32

Suggested Citation: Suggested Citation

Do, Minh Viet and Vu, Tram, Australian Foreign Currency Loans: Hedging or Arbitrage? (March 30, 2013). 2014 Financial Markets & Corporate Governance Conference, Available at SSRN: https://ssrn.com/abstract=2365087 or http://dx.doi.org/10.2139/ssrn.2365087