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The Use of FX Derivatives and the Cost of Capital: Evidence of Brazilian Companies

Large corporations, from both the western and eastern worlds, have been using derivative instruments as a tool to protect their indirect exposure, such as FX risks. This piece aims to study the behavior of the cost of capital of non-financial Brazilian companies when they use derivatives-based financial instruments to protect (or hedge) their cash flow. It was used a sample featuring 877 observations while working with data collected between 2004 and 2010 at 47 Brazilian companies. The Brazilian market was selected as it is an important emerging economy. Also, the Data Panel methodology (cross section with random effects) was used with the aim of testing the hypothesis that the use of derivatives as a risk management policy tool reduces companies’ cost of capital. In contrast to evidence found in other countries, the results rejected this hypothesis, showing that in Brazil there is a positive relationship between use of these tools and cost of capital. However, a more in-depth analysis based on the TACC (Total Average Cost of Capital) model for a Brazilian company, this hypothesis was not rejected after the 2008 crisis.