Liquidity Hedging with Futures and Forward Contracts
Yong Jae Shin
Hankyong National Unversity
October 31, 2013
Abstract: We present a model for developing hedging strategies using both futures and forward contracts. Although financially constrained firms suffer from liquidity problems, they can recover much of the lost value by hedging with futures contracts. However, firms with a limited cash balance must raise risky debt to remain operational for the long term, and then hedge their liquidity using futures and forward contracts. Adding forward contracts into hedging strategies raises the firm value higher than that when hedging with futures contracts alone. We numerically show that a financially constrained firm can increase its firm value close to that of a financially unconstrained firm by issuing minimal risky debt and hedging with both futures and forward contracts.