Summary on an Empirical Analysis on the Application of Financial

Derivatives as a Hedging Strategy among Malaysian Firms

(A journal article by-Jaafar Pyeman, Shahsuzan Zakaria, Nor Asyiqeen Mohd Idris)

Introduction:
Financial derivatives are underlying assets in the guise of Forward, Future, Option and Swap contracts
which are used to hedge, speculate, spread and arbitrage to manage the risks for the companies at interest
rates, currency exchange rates, and equity markets. Studies prove that the marketers of Malaysia have
widely grown their interest on derivative market. Although to reduce financial distress, underinvestment
costs, managerial costs and maximizing the firm value, risk exposed Malaysian corporations are extensively
adopting hedging using derivatives instruments but a survey from the Future Industry Association (FIA)
found that Bursa Malaysia Derivatives is ranked 39th in trading in the derivative market whereas South
Korea, Brazil, Singapore and Hong Kong, were ranked in the top 30 in trading in the derivative market in
2016.

Research Aim:
The main focus of this present study is to examine the elements of financial derivative usage in Malaysia.

Method & Data:

Relying on 58 nonfinancial Malaysian firms’ secondary data over the period 2011-2016, this study is aiming
to give insights to the policymakers to understand the usage of the derivatives as off balance-sheet risk
management tools for risk exposed Malaysian financial firms.

Analysis:
Regression Model:

Log of Total Notional ᵢ t = β0 + + β1Financial Distress ᵢ t + β2Underinvestment Cost ᵢ t + + β3Firm Size ᵢ t

+ β4Liquidity ᵢ t + β5Profitability ᵢ t + ε ᵢ t

Using Proxy Variable:

LNOTION= C+LTD_TE+CE_TA+LTA+QR+ROE

Co-efficient Values:

LNOTION= -2.649 +.003 LTD_TE** + 0.04 CE_TA*** + 0.961 LTA*** + 0.032 QR- 0.001 ROE
Here,

** Indicates Significant at 5% level

*** Indicates Significant at 1% level

The study includes derivatives as dependent variable and five independent variables (i) financial distress as
long term debt to total equity (LTD_TE), (ii) underinvestment cost as ratio of capital expenditure to total
assets (CE_TA), (iii) firm size as natural log of total assets (LTA), (iv) liquidity as quick ratio (QR) and (v)
profitability as return on equity (ROE) where the higher R-squared value represents the total variation the
dependent variable can be explained by the independent variables.

Findings:
After running the regression model the study found long term debt to equity ratio 5% significant to the
derivative which indicates firms with high debt level tends to enter in derivative instrument to hedge against
risk. It also showed that the investment growth through capital expenditure ratio which with 1%
significantly and positively related to the usage of derivatives in Malaysian firms. In the model, firm size
is showed by the natural log of total assets which is 1% significant with derivatives usage and means bigger
the firm size, the percentage of using derivatives is higher as the bigger size comes with great risk. For the
liquidity, the model showed that a firm’s liquidity has no impact on usage of derivatives which makes it
insignificant in the model. Last of all, the model proved profitability insignificant to derivative usage which
means high profitable firms are unlikely to face financial distress to use derivative instruments to hedge
probable risk.

Conclusion:
To conclude, due less awareness and knowledge fewer Malaysian firms are not comfortable with the usage
of derivative instruments. Though the study has some limitations as the notional value showed the sum of
different derivatives, but as per the previous studies this method provides more accuracy in data analysis.
The study helps to understand the pros and cons of using derivatives and showed that it can be a good option
for offbalance-sheet risk management tools for firms which can encourage the policymakers to emphasize
on using derivatives.