We build a dynamic cash and risk management model of a firm maximizing financing for its investment projects. Because of the option to abandon investment at low profitability and to expand investment at high profitability, hedging can be suboptimal. The model predicts that firms will engage in...

A hedging contract may be closed before maturity when a firm experiences an ``event of default,'' such as a credit downgrade, non-payment, or bankruptcy filing. Counterparties often exercise such termination right and are more likely to do so if the firm owes them money, leaving the firm exposed...