Risk Management: Coordinating Corporate Investment and Financing Policies

A general framework for analyzing corporate risk management policies is developed. It is observed that if external sources of finance are more costly to corporations than internally generated funds, there will typically be a benefit to hedging: hedging adds valud to the extent that it helps ensure that a corporation has sufficient internal funds available to take advantage of attractive investment opportunities. It is then argued that this simple observation has wide ranging implications for risk management strategies. It is shown how these strategies should depend on such factors as shocks to investment and financing opportunities. Exchange rate hedging strategies for multinational corporations are discussed, as well as strategies involving nonlinear instruments like options.