ABSTRACT
We examine firms' use of currency derivative instruments to differentiate among existing theories of hedging behavior. Our sample represents 372 of the Fortune 500 non-financial firms in 1991, all of which are potentially exposed to foreign currency risk either from foreign operations, foreign-denominated debt, or a high concentration of foreign competitors in their industries. We find that firms with high levels of research and development expenses and low quick ratios are more likely to use currency derivatives. These results are consistent with the predictions of Froot, Scharfstein, and Stein's (1993) underinvestment cost explanation for hedging. We also find that currency derivatives use is positively related to a firm's level of foreign pretax income, foreign sales, and foreign-denominated debt. These results are consistent with our argument that the benefits of hedging are greatest for firms with extensive foreign exchange rate exposure. Similarly larger firms and firms using interest rate or commodity derivative instruments are more likely to use currency derivative instruments which suggests that economies of scale exist for hedging activities. Finally, we find that firms with short-term exposure resulting from foreign operations or import competition are more likely to use forward contracts while users of swaps have higher levels of long-term foreign-denominated debt.

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