The Effect of Currency Derivatives on the Values of Listed Commercial Banks in Kenya

Abstract

Despite the use of derivative contracts by banks having increased over the past two decades, the effect of derivatives on risks and market value of banks is still largely unknown. Despite more widely available data on derivative usage, the evidence obtained from empirical research on its effects is mixed. One possible answer to such contradictory results is whether banks use derivatives for trading or hedging purposes. Previous studies have used data disclosed by all kinds of firms including non-financial firms and banks, in trying to improve understanding of how firms use derivatives.This study seeks to fill the existing research gap by conducting a study on the effect of foreign exchange exposure on the value on listed commercial banks in Kenya. The study intends to address the following question: What is the effect of currency derivatives on the value of listed commercial banks in Kenya?This study adopted a descriptive research design which generally describes characteristics of a particular situation, event or case.The population of the study will constitute 10 listed commercial banks that were in operation as at December 2013.The study findings established a positive coefficient for price of swaps at 5% level of significance. A unit increase in price of swaps will lead to 1.469 unit increase in the value of the firm. Price option is positively related to the value of the firm. With a p-value of 0.033, price of options is statistically significant at 5% level of significance. A unit increase in price of options will lead to 3.719 units increase in the value of the firm. Size of the bank is statistically significant at 5% level of significance in explaining the variation in the value of the firm. A unit increase in the bank‘s size will lead to 3.015 unit increase in the value of the firm. Based on the study findings, the study recommends that commercial banks should encourage the use currency derivatives because derivatives reduce the likelihood of financial distress by decreasing the variability in firm value, thus reducing the expected costs of financial distress. Commercial banks should avoid operating in debt. Leverage refers to the proportion of debt and equity in the capital structure of a firm. The financing or leverage decision is a significant managerial decision because it influences the shareholder‘s return and risk and the market value of the firm.