On the Determinants of Interest Rate Swap Usase By Larse Indian Companies

Abstract

Corporations in India, as in the rest of the world, use hedges to protect themselves against a quartet of exposures: swings in interest rates, commodity prices, foreign exchange rates and equity values. In the wake of the global financial crisis and significant losses on derivatives transactions announced by Indian companies recently, a study on the determinants of derivative usage by these companies is especially significant. An Interest Rate Swap (IRS) is one of the financial derivative instruments in which one party exchanges a stream of interest payments for another party's stream of cashflows, without exchanging the underlying debt. Since 1980s, interest rate swaps have been used by hedgers to manage their fixed and floating assets and liabilities. This paper models the factors which determine the Interest Rate Swap usage by large Indian companies. It is found that a total of 121 large Indian non-financial firms use derivatives. Out of these only 84 companies have disclosed the derivatives data. The companies which have disclosed IRS notional values are considered as sample for this study. This study uses cross sectional panel data for three years from 2007 to 2009 and applies multiple regression models. For this purpose, the firm specific characteristics such as financial distress cost, underinvestment cost, multinationality, economies of scale, firm size and agency variables are regressed against the notional amount of interest rate swap reported for hedging activities. It is found that R&D expenses, size of the firm, current ratio and revenues determine the usage of Interest rate swap, when it is scaled by size. It is also found that current ratio, revenues, debt equity ratio and size of the firm determine the usage of interest rate swap, when it is scaled by revenue. In the Indian context, this study has found support for the financial distress hypothesis, underinvestment hypothesis and economies of scale hypothesis.