Determinants of Hedging and Its Effects on Investment and Debt

Froot et al. [J. Finance 48 (1993) 1629] develop a framework in which a firm trades derivatives on the financial markets to coordinate its investing and financing decisions. This work specifies this framework by assuming that the firm faces a risk of going bankrupt. By deriving an approximated analytical solution, some properties of the optimal hedging strategy and the effects of hedging on a firm's investing and financing behaviour are developed and discussed. Numerical simulations of the nonclosed-form optimal solution are also obtained to validate the approximation.