Investment, Debt and Risk Management in a Context of Uncertain Returns to Investment.

In a context of uncertain returns to investment, a firm may face increasing costs of borrowing and uncertain value of its internal finance. Froot, Scharfstein, and Stein (1993) develop a framework where the firm can hedge against the fluctuations of its cash flow, in order to better coordinate investment and financing decisions. This work moves within this framework and finds an approximated analytical solution that allows one to better understand the properties of the optimal hedging strategy, as well as the effects of hedging on firm's investing and financing behaviour. Numerical simulations of the non closed-form optimal solution are also obtained to validate the approximation, which is thus supported by numerical evidence.