Research 341 Why UK Companies Hedge Interest Rate Risk

Essay by solo101usA, April 2009

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�PAGE � �PAGE �1� Business Research Article

Running head: Why UK Companies Hedge Interest Rate Risk

Research and Evaluation

University of Phoenix


The purpose of this paper is to examine the interest rate risk management practices of UK companies. In particular, the study examines five theories that been advanced in the literature to explaining why companies hedge tax and regulatory arbitrage; under investment, earnings and planning, financial distress, managerial self-interest, and economies of scale.

The Publication Studies in Economics and Finance Vol. 24 began as research article published in Emerald Group Limited in 2007. That article reported results of the 2002 meeting of scholars "to discuss the findings confirmed that all five theories of financial risk management have some support in practice." (Dhanani, 2002 p.72) However, while the responses to some questions supported the theories, other information elicited from the questionnaires did not. This finding demonstrates that studies that employ large disaggregated datasets that result in generalised conclusions often miss the dynamic nature of corporate affairs and that, as such, more qualitative research is needed in this area.

Interest rate risk (IRR) represents one of the key forms of financial risk that companies encounter. "In recent years, the management of IRR has gained prominence in the corporate sector of UK firms for several primary reasons. First, interest rate volatility in the UK has increased considerably in recent years. Rates in the UK, over the last few decades, have fluctuated from as high as 15 per cent to as low as 4 per cent" (Arnold, 2005). Second, there has been a dramatic increase in the use of corporate debt in UK companies with firms financing more of their funding requirements through shorter-term borrowings rather than equity. "Moreover, certain industries have witnessed a large increase in the number of highly leveraged...