How Does Currency Risk Impact Firms - New Evidence From Bank Loan Contracts JCF 2024

Journal of Corporate Finance 84 (2024) 102542
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Journal of Corporate Finance

journal homepage: www.elsevier.com/locate/jcorpfin
How does currency risk impact firms? New evidence from bank
loan contracts
Mikael C. Bergbrant a, Bill B. Francis b, Delroy M. Hunter c, *
a
Tobin College of Business, St. John’s University, Queens, NY 11439, USA
b
Lally School of Management, Rensselaer Polytechnic Institute, Troy, NY 12180, USA
c
Muma College of Business, University of South Florida, Tampa, FL 33620, USA
A R T I C L E I N F O A B S T R A C T
Editor: K Hankins We use unique features of the private credit market to examine if and how currency risk impacts
firms’ financing and whether currency risk is a priced systematic risk at the firm level. We find
JEL classifications: that currency exposure has a large impact on loan spreads. Decomposing loan spreads, we find
G12 that exposure increases the expected default loss premium and that internationalization, growth
G21
opportunities, and relationship intensify exposure’s impact. Further, exposure exacerbates firms’
G32
financing risk by increasing the need for collateral, reducing loan maturity, inducing monitoring
Keywords:
and covenant intensity, and influencing syndicate structure. However, exposure does not affect
Exchange rate exposure
the expected return premium in loan spreads; hence, currency risk does not appear priced in the
Bank loan contracting
Cost of debt classical sense and, therefore, should not affect the “true” cost of debt. Our findings imply that
Expected return premium while managers should be concerned about exposure’s impact on their access to, and terms of,
Expected default loss premium bank financing, they should not adjust hurdle rates on account of exposure when assessing in
Private credit market vestment projects.
1. Introduction
A central proposition of finance is that exchange rate risk could be priced in the cross section of firms’ expected returns (Adler and
Dumas, 1983). Consistent with this, exposure to currency risk influences three key strategic decisions of individual firms, each with
important consequences. These include decisions to engage in financial hedging, reduce capacity utilization as a means of operational
hedging, and increase hurdle rates in capital budgeting (Allayannis and Weston, 2001; Graham and Harvey, 2001; Kazaz et al., 2005;
Rampini and Viswanathan, 2010). This has prompted the observation that, for many U.S. firms, exchange rate risk has the single most
important influence on performance (Mello and Ruckes, 2005).
In this paper, we exploit unique features of bank loan contracts to ascertain whether exchange rate risk is priced and, more
generally, how exchange rate exposure impacts firms’ debt financing. This is important because the above strategic responses to
currency risk are predicated on the notion that currency risk is priced in, and adds a material risk premium to, expected returns.
Surprisingly, there is no robust evidence that currency risk is priced and, hence, that there is a currency risk premium in the firm-level
cost of equity for U.S. firms or firms domiciled in other countries (Vassalou, 2000; Griffin, 2002; Carrieri and Majerbi, 2006).
For the most part, existing work uses market, industry, and portfolio returns as test assets and finds mixed evidence that exchange
rate risk is priced (e.g., Jorion, 1991; De Santis and Gerard, 1998; Carrieri et al., 2006; Francis et al., 2008; Maurer et al., 2019; Karolyi
* Corresponding author.
E-mail addresses: bergbram@stjohns.edu (M.C. Bergbrant), francb@rpi.edu (B.B. Francis), dhunter2@usf.edu (D.M. Hunter).
https://doi.org/10.1016/j.jcorpfin.2024.102542
Received 24 December 2021; Received in revised form 29 October 2023; Accepted 4 January 2024
Available online 11 January 2024
0929-1199/© 2024 Elsevier B.V. All rights reserved.
M.C. Bergbrant et al. Journal of Corporate Finance 84 (2024) 102542
and Wu, 2021). In any case, we cannot infer results for individual firms from results based on aggregate test assets because, as
expounded below, aggregating stocks is more likely to conceal a common misspecification in asset pricing that could lead us to find
that a risk is priced even if it truly is not (Elton, 1999). Moreover, the empirical literature has not examined, at the individual firm level,
whether exchange rate risk is priced in the expected returns of, or has a broader influence on, the non-equity securities used in firms’
financing.
The bank loan market offers a different, and in many ways superior, setting compared to the equity market for our study because
each loan contract furnishes three components that are separately informative about how currency risk affects firm financing. First,
there is an expected default loss premium that compensates banks for default risk (Cooper and Davydenko, 2007; Campello et al., 2011).
A positive and significant association between exposure and the cross section of expected default loss premia would indicate that
exposure increases borrowers’ out-of-pocket loan expense. In addition, it would imply that our proxy for expected exposure (past
exposure calculated from individual firms’ equity returns) is likely to capture expectations, thus providing a critical validation check of
the suitability of our measure of exposure for the test of whether exposure is priced. Second, there is an expected return premium that
compensates for the systematic risk of the loan. If individual firms’ currency exposures are significantly associated with the cross
section of expected return premia, then currency risk would be priced and there would be a currency risk premium in firms’ (true) cost
of debt that should be included in the weighted average cost of capital (WACC). Third, loan contracts contain nonprice loan terms to
reduce default risk and the loss given default, as well as to mitigate information asymmetries and other concerns. As nonprice terms can
be costly and may reduce firms’ access to capital and financial flexibility they can be informative about whether exposure has broader
financial effects than previously documented.
Our study boasts two additional benefits derived from using bank loans. One benefit is that loan pricing is less susceptible to model
misspecification than equity or bond pricing, increasing the odds that we will unearth the true answer to the question whether currency
risk is priced. This is because banks set loan terms at the loan initiation and generally do not subsequently adjust these terms on
account of realized risk (see next paragraph). Consequently, at the loan initiation date banks form expectations about both the return
premium on the loan and the borrower’s currency exposure over the contract period. In stark contrast, because equity or bond in
vestors can react to information surprises (e.g., currency shocks) at any point during the investment period, they are less likely to
reflect a (currency) risk premium in asset prices at a given point in time. If the (currency) shocks are large, or are positively correlated
over time such that their cumulative effects are large, then realized asset returns used in asset pricing tests would be a poor proxy for
expected returns (Elton, 1999). Our use of the expected return and expected default loss premia in loan spread allows us to take
advantage of banks’ expectations. We rely on this feature in our estimations in Section 3.2. The second benefit is that the syndicated
loan market (the segment we study) is the largest source of new corporate capital globally (Sufi, 2007).1 Hence, if exposure affects the
various aspects of bank loans, then it should have a substantial effect not only on firms’ marginal financing cost, but also on their
hedging, financing, and investing decisions, thus warranting the importance attributed to currency risk by managers.
A few caveats are in order. First, even though we use the private debt market to investigate the impact of exposure on spreads, our
measure of exposure is estimated in the equity market. However, if anything, this should bias against us finding a link between
exposure and loan contracts. Second, banks set covenants and performance pricing that could be triggered by adverse exchange rate
movements and could, therefore, adjust the cost of the loan to the borrower subsequent to initiation. To the extent that they do this, the
loan spread might not reflect the expected exposure and risk price at the loan initiation. Finally, for various reasons discussed in
Section 6, banks may not reflect the true level of risk in loan spreads.
Using 32,000 firm-loans between 1995 and 2017, we find that exposure to a broad trade-weighted currency index, estimated one
month prior to the loan date, significantly increases loan spreads. If a firm’s exposure were to change from the equivalent of one
standard deviation below the sample mean to one standard deviation above the mean its loan spread would increase by about 6%.2 For
the average loan, this translates to 12 basis points and an incremental direct cost of $1.817 million over the average term of about four
years.
We find that about 41% of the average loan spread is attributed to expected default loss premium. As far as we are aware, this is the
first large-sample estimate of default premium in bank loan spreads. The large default premium implies that using quoted bank loan
rates as the cost of bank debt materially overstates the average firm’s WACC. Next, we examine the relation between expected default
loss premium and exposure. We find that exposure positively and significantly impacts the default premium. This result validates our
measure of exposure. Notably, moving from low exposure to high exposure, the average firm’s expected default loss premium would
increase by about 64%, resulting in a substantial increase in out-of-pocket loan expense. In addition, we find that exposure’s impact on
the default premium increases with internationalization, growth opportunities, and relationship loans, variables which we hypothesize
are incrementally informative to banks about borrowers’ exposure, and decreases for secured loans, which limit creditors’ loss given
(currency-induced) default.
We then examine if currency risk is priced. The finding is striking; exposure does not significantly impact the expected return
premium in loan spreads and, therefore, does not have a systematic effect. These findings are robust to accounting for potential
1
U.S. loan volume was $2.2 trillion in 2015, more than new issues of bonds ($1.5 trillion) and stocks ($230 billion) together (see http://www.
sifma.org/research/statistics.aspx, http://share.thomsonreuters.com/general/PR/Loan-4Q15-(E).pdf, and http://dmi.thomsonreuters.com/
Content/Files/4Q2015_Global_Equity_Capital_Markets_Review.pdf).
2
All numerical assessments of the impact of exposure uses the transition from “low” to “high” exposure with an exposure equal to one standard
deviation below (above) the mean, about 0.13 (2.30), based on the absolute value of exposure to a broad trade-weighted currency index (see
Equation 1) and summary statistics in Panel B of Table 1.
2
endogeneity and allowing the impact of exposure to vary with currency and equity market conditions. We also address the concerns
that our trade-weighted currency index is not specifically designed to capture the systematic effect of exchange rate changes or allow
sufficient cross-sectional heterogeneity in the currencies to which firms are exposed, therefore underestimating the price of exchange
rate risk. Re-estimating exposure using different approaches and currency indices, individual currencies, and currency factors
developed by Lustig et al. (2011, 2014; hereafter LRV (2011) and LRV (2014) and Verdelhan (2018) to capture the common variation
in many currencies, we continue to find that currency risk does not contribute an economically meaningful risk premium to the ex
pected return premium (while it continues to strongly impact the default premium).
Next, we examine the nonprice terms of firms’ loan contracts to ascertain whether exchange rate risk has incremental effects on
loan contracting beyond increasing the default premium in loan spread. This deepens our understanding of how exchange rate risk
affects firms’ financing because nonprice loan terms can be costly to borrowers and the effects of exposure on nonprice terms cannot be
inferred from determining whether and how exchange rate risk affects loan spread. We find that exposure shortens loan maturities and
increases firms’ likelihood of pledging collateral. These findings imply that exposure causes credit constraints, especially for collat
erally constrained firms (Rampini and Viswanathan, 2010).
In addition, exposure increases annual and standby fees, as well as financial covenant intensity. These findings suggest that bor
rowers’ exposure reduce their transparency and force banks to increase their monitoring efforts, given that these fees are standard
proxies for information asymmetries between banks and borrowers (Sufi, 2007). These findings also suggest that creditors restrict
managers’ flexibility on account of exposure, because covenants reduce managerial flexibility (Roberts and Sufi, 2009). As foreign
banks have substantially increased loan funding in the United States (Berg et al., 2016), we examine whether exposure affects foreign
lender participation. We find that foreign lender participation decreases as firms’ exposure increases. In particular, we find that
foreign-lender loan share and the probability that foreign lenders provide the majority of funds in the syndicate decrease with
exposure. Perhaps, this is due to the higher costs of monitoring, which attracts fewer lenders. A bright side of this syndicate-structure
effect is that lender coordination problem and borrowers’ loan renegotiation cost decreases with exposure (Bolton and Scharfstein,
1996; Lee and Mullineaux, 2004; Roberts and Sufi, 2009).
Our paper makes several important contributions. First, it contributes to the literature on currency exposure (Jorion, 1990; Bartov
and Bodnar, 1994; Miller and Reuer, 1998; Griffin and Stulz, 2001; Williamson, 2001; Chang et al., 2013; Hutson and Laing, 2014;
Francis et al., 2017; Bruno and Shin, 2020; Krapl, 2020) by being the first to combine aspects of the debt, currency, and equity markets
to address an issue that has been a challenge for more than four decades (Karolyi and Wu, 2021). We document that exposure does not
command an expected return premium in credit spreads, but it elicits a substantial default premium as well as materially influences the
microstructure of private debt contracts. Coupled with the absence of robust evidence of a currency risk premium in individual firms’
stock returns, our findings suggest that currency risk is completely diversifiable and, therefore, should have no effect on the WACC.
Our paper also contributes to the literature on hedging (Smith and Stulz, 1985; Froot et al., 1993; Allayannis and Weston, 2001;
Campello et al., 2011). While hedging is partly predicated on the notion that currency risk increases the likelihood of financial distress,
our paper is the first to document the actual cost of expected default due to currency risk. Firms may bear the cost of potential currency-
induced financial distress because of their lack of hedging capacity (Rampini and Viswanathan, 2010), hedging counterparties’
constraints (Bergbrant and Hunter, 2018), impracticability of hedging some aspects of exposure, and the suboptimality of fully hedging
(Black, 1990). However, in interpreting our results, it should be borne in mind that many firms may make active choices regarding
their level of unhedged exposure. These choices may be related to managerial risk-taking incentives (Francis et al., 2017) or other
“human elements” (Bodnar et al., 2019). Our estimated bank cost of unhedged exposure represents the lower bound of the imputed
cost to fully hedge the remaining exposure. Our results suggest that borrowers trade off unfavorable loan terms due to unhedged
exposure for the added cost of fully hedging.
Finally, our paper contributes to the pricing of default risk. While there is empirical evidence of a default premium in bond yield
spreads (Elton et al., 2001; Longstaff et al., 2005; Giesecke et al., 2011; Schwert, 2017), our work adds some clarity to the question of
the particular risks that contribute to the default premium. We are the first to document that currency risk is a major determinant of the
default premium. Relatedly, we contribute to the loan pricing literature (Sufi, 2007; Graham et al., 2008; Bae and Goyal, 2009; Valta,
2012; Campello and Gao, 2017) by documenting how banks design loan contracts to account for borrowers’ currency exposure.
2. Literature review and hypotheses development
2.1. Previous research
Theory predicts that because residents of a given country prefer returns in their domestic currency, in the presence of the violation
of purchasing power parity (PPP), exchange rate risk could be a priced systematic risk that contributes an economically material risk
premium to the expected returns of risky securities (Adler and Dumas, 1983). The persistent deviation from PPP is well documented
(Frankel and Rose, 1995). Consequently, there is a strong basis for the expectation that currency risk is priced.
However, empirical evidence using aggregate test assets is mixed. For instance, there is evidence that currency risk is priced in
national stock market returns (De Santis and Gerard, 1998; Carrieri et al., 2006; Maurer et al., 2019), but the magnitude of the currency
risk premium in the U.S. stock market returns varies substantially across studies (e.g., compare De Santis and Gerard, 1998 and Maurer
et al., 2019). At the regional, industry, or portfolio level, the evidence is similarly mixed. Francis et al. (2008) finds a substantial risk
premium in U.S. industries, but Karolyi and Wu (2021) finds evidence of both currency risk premium and risk discount, while Jorion
(1991) finds that currency risk is not priced.
Lustig et al. (2011, 2014) and Verdelhan (2018) develop new currency risk factors designed specifically to capture systematic
3
variation in exchange rates and, thus, address the concern that changes in trade-weighted currency indices used in much of the
literature might not adequately capture the systematic component of exchange rate changes. Using these indices, Maurer et al. (2019)
and Karolyi and Wu (2021) find evidence that currency risk is priced, but they do not study individual stock returns.
At the firm level, there is an even starker absence of robust evidence that currency risk is priced. Griffin (2002) finds that currency
risk is not priced using data from four countries. Vassalou (2000) finds that a residual component of exchange rate changes that reflects
variation due to individual exchange rates is priced, but not the systematic (common) component of exchange rates. Similarly, Carrieri
and Majerbi (2006) finds that currency risk is priced in individual stocks of some emerging markets, but the evidence is primarily
related to the country-specific bilateral exchange rate and not a broad currency index.3
2.2. Hypotheses development
Currency exposure induces cash flow volatility, thus increasing the likelihood of shortfalls that could delay debt repayment. Hence,
banks’ expectation of currency-induced cash flow volatility could affect their perception of borrowers’ default risk. Consequently, it
would be expected that banks include a component of the expected default loss premium in loan spreads as compensation for bor
rowers’ currency exposure. We hypothesize that currency exposure increases the expected default loss premium in loan spreads.
As previously noted, theory predicts that currency risk could be priced in the expected returns of stocks. If that is the case, this
should hold more generally for other risky assets such as bank loans. More specifically, the expected return premium in loan spreads
should be sensitive to currency risk because currency exposure could cause pro-cyclical variation in firms’ cash flows if exchange rates
are relatively stable (volatile) and exposure is lower (higher) at the business cycle peak (trough). This implies that exposure could add
to the undiversifiable business cycle risk. Consequently, exposure would increase the discount rate used to value firms’ cash flows. We
hypothesize that exposure is priced in the expected return premium in loan spreads.
Greater cash flow volatility arising from exposure might also lead to the design of nonprice loan terms that reflect creditors’
sensitivity to borrowers’ currency exposure. For instance, nonprice loan terms could reflect the concern that currency risk could in
crease firm opacity (i.e., information asymmetry) because cash flow volatility reduces disclosure (Bertomeu et al., 2011) and lower
analyst following (Minton and Schrand, 1999; Lang et al., 2003). Creditors could respond to currency-induced information asymmetry
risk in various ways.
First, they could limit loan supply to borrowers with greater exposure in order to mitigate creditor loss given default, consistent
with the view that borrowers’ information opacity increases the probability that banks restrict loan supply (Dennis and Mullineaux,
2000). Consequently, we hypothesize that greater exposure leads to a higher likelihood of pledging collateral and receiving shorter loan terms.
Second, creditors could form loan syndicates that reflect their concern about borrowers’ currency-induced cash flow volatility and
the related information asymmetry. For instance, firms with greater exposure might have more concentrated syndicates as lead
bankers attempt to mitigate the free-rider problem in information gathering and monitoring when borrowers are opaque (Graham
et al., 2008). In addition, firms with a higher probability of default tend to borrow from more concentrated syndicates to reduce the
lender coordination problem in the event of financial distress and the need for loan restructuring (see, e.g., Bolton and Scharfstein,
1996; Lee and Mullineaux, 2004). It is also possible, however, that lead banks want to limit their exposure to the higher risk and,
therefore, increase the size of the syndicate (and reduce their share of the loan) to spread the risk more broadly, resulting in less
concentrated syndicates. We hypothesize that borrowers’ syndicate concentration increases with exposure.
Third, creditors could form syndicates to reduce the effects of borrower opacity specific to firms with higher exposure. Since a
substantial portion of currency exposure for U.S. firms arises from potentially more opaque foreign sales and operations, this would be
of concern to (domestic) lead banks. This is because the level of earnings opacity and, hence, information risk, has been shown to be
larger in foreign countries than in the U.S. and investors demand a higher cost of equity from firms with greater earnings opacity (see
Bhattacharya et al. (2003) and references therein). Since charging a higher loan spread compensates lenders for earnings opacity but
does not mitigate opacity to allow lenders to “see through it” they may take alternative action in this regard, such as enlisting foreign
lenders from countries in whose markets U.S. firms conduct their foreign operations. On the other hand, the arguments given above for
higher exposure leading to higher syndicate concentration could also result in less reliance on foreign lenders. That is, firms whose
exposure increases suddenly might rely on fewer lenders in total and place greater reliance on their domestic (home country) lenders
for funding to reduce possible loan restructuring and lender coordination costs (Bolton and Scharfstein, 1996; Lee and Mullineaux,
2004; Roberts and Sufi, 2009). We hypothesize that for firms with greater exposure, lead banks increase foreign lender participation as foreign
lenders are more likely to “know” the firms’ foreign operations, consistent with existing evidence on syndicate structure (see, e.g., Sufi,
2007).4
Fourth, creditors could more closely screen and monitor borrowers as their exposure increases. Theory predicts that screening and
monitoring represent banks’ attempt to force borrowers to reveal private information about their creditworthiness (Thakor and Udell,
1987). Hence, we hypothesize that screening and monitoring costs (upfront and annual fees) as well as commitment and standby fees increase
with exposure. Given exposure-related borrower opacity, and consistent with the view that information asymmetry could affect the
3
Campello et al. (2011) finds that hedging reduces the expected return premium, but we cannot infer that currency risk is priced. First, currency
hedging could be impacting other priced risks since firms use currency hedges to manage other risks (Giambona et al., 2017). Second, Campello
et al. does not separate interest rate and currency hedges in their data.
4
Even if foreign lenders “know” a U.S. borrower’s foreign operations, they could still find the firm, on a net basis, relatively opaque due to, for
instance, the complexity of its U.S.-based operations.
4
intensity of covenants in loan contracts (see, e.g., Sufi, 2007), lenders might also impose covenants as a part of their effort to reduce
loss given default. Hence, we also hypothesize that covenant intensity increases with firms’ exposure.
3. Data and methodology
3.1. Loan pricing data and controls
We use 32,035 firm-loans between 1995 and 2017. All variables are defined in Appendix 1. The bank loan information is from LPC
Dealscan, which is compiled from SEC filings and banks’ self-reporting.
For each loan, Dealscan reports a loan spread, which is the difference between the contracted rate on the loan and the relevant
LIBOR rate. The loan spread can be decomposed into two components (Cooper and Davydenko, 2007; Campello et al., 2011). The first
is an expected default loss premium. This is the compensation for the firm-specific expected default risk of the loan and is included in
the loan spread because private debt issues have a non-zero probability of default and, consequently, the debt holder demands
compensation for the expected loss given default. The second component is the expected return premium. Like its equity, the firm’s
debt is affected by systematic risk.5 Hence, debtholders should require a risk premium for holding (private) debt in the same way that
shareholders require a premium for holding stocks with systematic risk. The expected return premium is the compensation to debt
holders for the nondiversifiable risk of the debt (Elton et al., 2001; Cooper and Davydenko, 2007). It is the nondiversifiable component
of the promised loan spread that should be added to, say, the weighted average cost of capital or used in any assessment in which it
would be appropriate to apply the cost of equity instead of the firm-specific (equity) return.
Equity-related data is from CRSP, accounting data is from Compustat, and macro-economic data is from the St. Louis Federal
Reserve Bank. When analyzing characteristics that are related to our measure of exposure, we augment the accounting data from
Compustat with foreign currency denominated revenue using FactSet Revere data. In addition, we follow Anderson et al. (2022) and
search 10-K filings for (general and currency) hedging-related words and use the approach by Dyreng and Lindsey (2009) to search for
subsidiary data from Exhibit 21 of the 10Ks. Panel A of Table 1 provides summary statistics for the loan-, firm-, and macro-level
variables. We winsorize continuous variables at the 2.5% and 97.5% tails. The summary statistics are similar to those presented in
other papers in the bank loan literature.
3.2. Measure of exchange rate exposure and empirical approach
We take a two-step approach that is broadly consistent with standard tests of asset pricing models, but reflects specifics of the
private credit market.6 In the first step, we estimate each firm’s exposure using a time-series regression of 52 weekly observations up to
four weeks prior to the firm-loan date,
rt = α + βfx Δfxratet + βm rmt + νt , (1)
where rt is the firm’s one-week holding period stock return, Δfxratet is the one-week percentage change in a broad trade-weighted
currency index (Broad), and rmt is the one-week return on the stock market. Unless otherwise stated, our proxy for exchange rate
7
exposure throughout the paper is β̂fx , consistent with a large literature (see, e.g., Jorion, 1990, 1991). We refer to this as a market-
augmented measure of exposure. We estimate exposure over a single year as exposure is highly time varying (Francis et al., 2008;
Krapl, 2020).
Exchange rates are quoted as foreign currency per dollar. Hence, an increase in the index represents an appreciation of the dollar.
We report summary statistics on the absolute values of the market-augmented exposure to the broad exchange rate index, Broad, in
Panel B of Table 1. The distributions of the absolute exposures are similar to those in existing work. As discussed throughout the paper,
we also conduct our tests on estimates of exposure related to bilateral exchange rates, other trade-weighted indices, five currency
factors from Lustig et al. (2011, 2014, hereafter LRV) and Verdelhan (2018), and using a Fama-French-augmented approach.
In Panel C, we report the correlations between our main measure of exposure (Broad) and several firm-level variables. Estimates of
exposure do not reveal the different underlying economic mechanisms that give rise to cross- and within-firm variation in exposure.
Understanding this aspect of exposure is important because different possible mechanisms could have different implications for
quantifying and pricing currency risk (see Bergbrant et al., 2014). Moreover, since our exposure measure is based on firm returns, it is a
5
Elton et al. (2001) shows that standard systematic risk factors that affect stock returns also affect bond returns.
6
Because the vast majority of bank loans are not publicly, and frequently, traded, we cannot obtain a time series of bank loan spreads for an
individual loan in order to estimate the exposure of (the components of) loan spreads. Hence, we use the exposure of the borrower’s stock returns,
Equation (1), as a proxy.
7
This return-based exposure captures the overall impact of currency changes on firms’ future expected cash flows and, hence, incorporates market
participants’ expectations and the overall impact of currency shocks on firm value.
5
Table 1
Summary statistics.
Panel A: Loan, firm, and macro variables
Obs Mean Std Min Max
Loan Level
Loan spread (basis points)a 32,035 206.572 129.611 22.500 555.000
Default risk premium (basis points)a 24,142 78.529 90.253 0.000 353.878
Expected return premium (basis points)a 24,142 111.342 78.842 9.346 320.244
Loan maturity (months)a 32,035 49.089 22.498 9 95
Loan size ($m)a 32,035 386.022 545.133 2 2370
Ln(upfront fee) (basis points) 6882 3.566 1.110 0.693 5.521
Ln(annual fee) (basis points) 6061 2.549 0.697 1.099 4.248
Ln(commitment fee) (basis points) 12,924 3.428 0.566 2.015 4.472
Ln(standby fee) (basis points) 8692 4.989 0.648 3.296 5.991
Performance pricing dummy 32,035 0.439 0.496 0 1
Relationship dummy 32,035 0.517 0.500 0 1
Secured loan dummy 32,035 0.549 0.498 0 1
Syndicate concentration (of loan shares) 7980 3544.167 3446.369 185.82680 10,000
Foreign lender share 7980 23.969 28.516 0 100
Foreign majority lender share 7980 0.163 0.370 0 1
General covenants 32,035 0.237 0.457 0 3
Financial covenants 32,035 0.843 0.824 0 4
Total covenants 32,035 1.080 1.073 0 6
Firm Level
Log firm size (assets in $m) 32,035 7.195 1.904 2.906 10.723
Market-to-book ratio 32,035 1.710 0.836 0.798 4.644
Leverage 32,035 0.311 0.195 0.000 0.811
Profitability 32,035 0.129 0.078 − 0.091 0.318
Tangibility 32,035 0.322 0.239 0.027 0.856
Cash flow volatility 32,035 1.206 4.047 0.013 22.297
Z-score 32,035 1.647 1.148 − 1.055 4.336
Internationalization 19,600 0.862 1.421 0.000 6.873
Competition 30,247 2.806 2.815 1 13.446
Macro Level
Default spread (%) 32,035 0.93 0.32 0.55 3.38
Term spread (%) 32,035 1.13 0.93 − 0.41 2.83
FXVol 32,035 0.006 0.002 0.003 0.015
VIX 32,035 19.980 7.256 9.890 80.060
Panel B: Exchange Rate Exposure
Obs Mean Std Min Max
Exposure (Market-augmented)
Broad currency index (Abs) 32,035 1.218 1.085 0.000 4.277
Broad currency index (Pos) 15,133 1.159 1.024 0.000 3.763
Broad currency index (Neg) 16,902 − 1.271 1.133 − 4.277 0.000
Broad currency index (Significant Abs) 4432 2.577 1.064 0.508 4.277
Broad currency index (Insignificant Abs) 27,603 1.000 0.916 0.000 4.277
Panel C: Selected Pairwise Correlations between Absolute Exposure and Firm Characteristicsb
Ln(firm size) − 0.226 Foreign currency revenue 0.034

Market-to-book ratio − 0.045 Foreign currency revenue concentration 0.055
Leverage 0.044 Subsidiary_10K − 0.070
Profitability − 0.143 Subsidiary_countries_10K − 0.127
Tangibility 0.041 General_hedge_10K − 0.097
Cash flow volatility 0.045 Currency_hedge_10K − 0.123
Z-score − 0.115 Competition 0.070
This table presents descriptive statistics. All variables are defined in Appendix 1.
a
As Ln(x) ∕= Ln(x) , we take the exponential of Ln(x) reported in DealScan for each loan and report the mean in the first row to facilitate the analysis of
the empirical results.
b
All correlations are significantly different from zero at the 5% level.
6
post-hedging estimate and, therefore, it might not be (ex-ante) obvious which firms would have high exposure as the cross-firm
variation in exposure, even within a given industry, could be significant. The correlations are generally consistent with prior work.
For instance, we find that exposure is lower for firms that are larger, have greater growth opportunities, are more profitable, and have
lower bankruptcy risk. This is possibly because firms with these characteristics are more likely to hedge.8 Exposure is positively related
to leverage, tangibility, and cash flow volatility.
We augment the above list with several variables (most of) which the theoretical literature identifies as determinants of exposure
(e.g., Luehrman, 1990). If the correlation between our measure of exposure and these variables are consistent with this literature, then
this provides validation that our measure captures (post-hedging) exchange rate exposure. Consistent with expectations, we find that
exposure is higher for firms that receive a greater proportion of revenue that is denominated in foreign currency, foreign revenue that
is concentrated in fewer currencies, as well as firms that face higher competition. In contrast, exposure is negatively correlated with
proxies for the intensity of general and currency hedging, as well as the number of foreign subsidiaries and countries in which a firm
has subsidiaries (which serve as an operational hedge).
In a second step, we examine if exposure affects loan spread, expected default loss premium, expected return premium, and
nonprice terms by regressing these variables on the absolute value of exposure, standard loan pricing factors, and firm (αi), time (τt),
loan type (ℓj), and loan purpose (℘k) fixed effects:
⃒ ⃒
loan termit = δ⃒̂β fxit ⃒ + C′loan pricing factorsit + αi + τt + ℓj + ℘k + εit . (2)
We use the natural log of loan spreads, expected default risk premia, and expected return premia to be consistent with the literature
that uses the log of loan spreads to account for skewness in spreads (Graham et al., 2008). We use the absolute value of exposure in our
main tests because, regardless of the sign of the exposure, firms with higher magnitude of exposure are more susceptible to a sub
stantial currency-induced reduction in its cash flow and increase in cash flow volatility. Given that we expect a positive currency risk
premium (the product of δ and βfx) in loan spread, we use the absolute exposure in Eq. (2). This implies that, if we estimate Eq. (2) by
signed exposures we would expect negative (positive) exposures to be associated with a negative (positive) estimate of δ. The use of
absolute exposure is common in the literature (Doidge et al., 2006; Francis et al., 2008; Wei and Starks, 2013).
Although we use absolute exposures in our main models, it is possible that positive and negative exposure could have different
impacts on loan attributes. This is because positive and negative exposure might arise through different channels, and it is possible that
lenders are more concerned with exposure arising from channels that could be harder to mitigate. Hence, we estimate the models split
by exposure (or allowing for positive and negative exposures to have an asymmetric effect through interaction models) for our main
tests.
In estimating Eq. (2), we rely on the established literature on bank loan pricing (Graham et al., 2008; Bae and Goyal, 2009;
Campello et al., 2011; Valta, 2012; Campello and Gao, 2017). Much of the literature follows the empirical model specified in Graham
et al. (2008). The model explains the cross section of loan spreads using a mix of macroeconomic factors that have been shown to
explain returns on fixed-income securities, firm-specific time-varying characteristics, loan characteristics, and idiosyncratic fixed
effects. We augment this model with the estimate of the quantity of firms’ exposure to exchange rate risk. Similar to the other mac
roeconomic factors in the model, each firm’s exposure is estimated at a time determined by its loans, with each firm exposed to the
same exchange rate risk factor(s).
We also adjust standard errors for clustering at the firm level (Petersen, 2009). As noted above, banks should embed their ex
pectations of the compensation for the systematic and default risks of the loan in the loan spread at the time of the loan agreement. This
implies that we can relate the measure of exposure (i.e., the quantity of currency risk) to the expected, not the realized, return on the
loan, thus eliminating the previously described mispricing concern raised by Elton (1999) about equity (or bond) pricing. Combining
the above advantage, the estimation of exposure four weeks prior to the loan date, and a standard loan pricing model substantially
reduces, if not eliminates, the likelihood of omitted variables, reverse causality, simultaneity, and other model misspecifications.
Nonetheless, in Section 4.4, we take additional steps to ensure that our results are not due to potential endogeneity.
4. Results
4.1. Effect of exposure on loan spreads
We start by estimating Eq. (2) for loan spreads to provide an estimate of the overall direct interest expense due to exposure. The
results, reported in Table 2, indicate that (absolute) exposure has a statistically significant impact on loan spreads. Exposure also has a
material economic impact. The exposure coefficient in the model with the full set of fixed effects, Model (4), is 0.025 and is highly
significant (t-statistic = 5.57). This implies that if a firm’s exposure were to change from a low of one standard deviation below the
sample mean, approximately 0.13, to a high of one standard deviation above the mean, about 2.30, this would lead to an increase of
8
Many firms that hedge do so in the over-the-counter derivatives market. The vast majority of these transactions require cash collateral as
providers of hedging services are concerned about counterparty risk (Bergbrant and Hunter, 2018). Larger and more profitable firms with lower
bankruptcy risk tend to have more cash for collateral and pose less counterparty risk, while firms with more growth opportunities have greater need
to hedge.
7
Table 2
Regression of loan spreads on exchange rate exposure.
(1) (2) (3) (4) (5) (6)
Full sample Full sample Full sample Full sample Negative exposures Positive exposures
Absolute exposure 0.048*** 0.053*** 0.023*** 0.025*** − 0.021*** 0.036***

OLS t-statistic (11.087) (12.170) (5.251) (5.573) (− 3.255) (4.326)
Double bootstrap t-statistic [16.483] [17.065] [6.912] [7.576] [− 4.260] [7.286]
Ln(firm size) − 0.100*** − 0.114*** 0.039*** − 0.099*** − 0.111*** − 0.095***
(− 17.858) (− 19.708) (3.597) (− 8.250) (− 6.527) (− 5.045)
Market-to-book ratio − 0.086*** − 0.083*** − 0.063*** − 0.063*** − 0.053*** − 0.068***
(− 9.822) (− 9.862) (− 6.271) (− 6.604) (− 3.578) (− 4.740)
Leverage 0.704*** 0.717*** 0.515*** 0.500*** 0.515*** 0.476***
(20.437) (21.382) (10.591) (11.258) (7.209) (6.619)
Profitability − 1.103*** − 1.158*** − 0.947*** − 1.045*** − 0.923*** − 1.201***
(− 11.470) (− 12.022) (− 7.381) (− 8.544) (− 4.865) (− 5.829)
Tangibility − 0.187*** − 0.114*** − 0.287*** − 0.170** − 0.264** − 0.137
(− 6.530) (− 4.067) (− 3.449) (− 2.210) (− 2.367) (− 1.123)
Cash flow volatility 0.008*** 0.006*** 0.001 0.000 0.001 0.001
(6.412) (5.273) (0.568) (0.187) (0.461) (0.618)
Z-score − 0.057*** − 0.048*** − 0.056*** − 0.037*** − 0.044** − 0.038*
(− 8.404) (− 7.287) (− 3.935) (− 2.764) (− 2.231) (− 1.687)
Ln(loan maturity) 0.122*** 0.084*** 0.071*** 0.056*** 0.053*** 0.058***
(14.134) (9.889) (7.997) (6.571) (4.382) (4.862)
Ln(loan size) − 0.085*** − 0.101*** − 0.100*** − 0.113*** − 0.119*** − 0.106***
(− 14.766) (− 16.854) (− 14.505) (− 16.125) (− 11.879) (− 12.465)
Perform. pricing dummy − 0.108*** − 0.073*** − 0.091*** − 0.062*** − 0.064*** − 0.055***
(− 11.232) (− 7.694) (− 9.310) (− 6.653) (− 4.809) (− 3.830)
Relationship dummy 0.014 − 0.017* − 0.009 − 0.030*** − 0.034** − 0.031**
(1.607) (− 1.921) (− 0.945) (− 3.343) (− 2.509) (− 2.193)
Term spread 0.173*** 0.078*** 0.170*** 0.083*** 0.106*** 0.081***
(32.688) (5.387) (30.935) (5.729) (4.716) (3.448)
Default spread 0.261*** 0.086*** 0.262*** 0.119*** 0.119*** 0.097***
(19.996) (4.041) (19.169) (5.377) (3.269) (2.660)
Firm FE No No Yes Yes Yes Yes

Year FE No Yes No Yes Yes Yes
Loan type FE Yes Yes Yes Yes Yes Yes
Loan purpose FE Yes Yes Yes Yes Yes Yes
Observations 32,035 32,035 32,035 32,035 16,902 15,133

Clusters (firms) 4436 4436 4436 4436 3603 3532
Adj. R2 0.530 0.574 0.689 0.722 0.729 0.752
This table reports results from ordinary least squares in which the dependent variable is the natural log of the loan spread for an individual loan. All
variables are defined in Appendix 1. The (t-statistics) in parentheses are based on robust standard errors that correct for firm-level clustering. The [t-
statistics] in square brackets are based on double bootstrapped standard errors. *, **, and *** represent significance at the 10, 5, and 1% levels based
on the robust standard errors.
about 5.57% in the firm’s loan spread.9 Given the average loan spread of 206.57 basis points, this would amount to about 12 basis
points. For the average loan size and maturity of $ 386,022,200 and 49.09 months, the incremental direct loan cost would be around
$1,817,000.
The loan pricing factors are generally significant and of the expected signs. That is, firm size, market-to-book, profitability, asset
tangibility, z-score, loan size, performance pricing, and relationship loans are inversely related to loan spreads in the full model (Model
4). Conversely, leverage and loan maturity are associated with higher loan spreads, as are the term and default spreads.
The above finding holds for both positive and negative exposures, Models (5) and (6) (as noted above, observe that the negative
coefficient estimate in Model (5) multiplied by a negative exposure yields a positive or higher spread), supporting the claim that,
regardless of the sign of a firm’s exposure, lenders perceive currency risk as potentially consequential for firms’ cash flows. The results
also hold for statistically significant and insignificant exposures (Models 1 and 2 of Appendix 2). Given that large exposures are more
( ( ( ⃒ ⃒) )) ⃒ ⃒
9
The change in loan spread is approximately 100 × exp ̂ β fx ⃒ − 1
δ × ⃒̂ , where ̂
δis the coefficient estimate from Eq. (2) and ⃒̂
β fx ⃒ is the
change in exposure from the low- to the high-exposure state. The change in interest cost is (percentage change in spread in decimal × avg. spread in
decimal × avg. loan size in $m × avg. maturity in years).
8
likely to be significant (2.58 for significantly exposed firms versus 1.00 for insignificantly exposed firms; see Table 1), this suggests that
excluding insignificant exposures would bias the tests to firms with large exposures. It also suggests that even statistically insignificant
exposures can be economically meaningful and important to firms.10 In total, this reinforces the standard practice in the literature of
including all firms (regardless of the significance of their exposures) in the second stage models. Finally, it should be noted that
although the exposure has a larger impact for significantly exposed firms (supposedly because exposure is estimated with less noise for
these firms), the magnitude of the impact for insignificant firms is large and important (and of similar statistical significance to the full
sample).
Since the estimate of exposure is a generated regressor, the standard errors (and corresponding t-statistics) of the OLS coefficient
estimates from Eq. (2) could be biased. We, therefore, estimate standard errors based on double bootstrapping and report the cor
responding t-statistics below each OLS t-statistic for the exposure proxy. The fact that the double bootstrapping results in much lower
standard errors, and correspondingly larger t-statistics suggests that the OLS t-statistics are conservative.
4.2. Does exposure affect the default premium?
Although whether exposure is priced in expected stock returns has been widely debated, there should be less controversy regarding
whether and how exposure is related to the expected default loss premium. That is, because exposure increases cash flow volatility and,
hence, the risk of financial distress, exposure should be positively related to the expected default loss premium. However, analyzing
whether exposure has a positive and significant relation to the default premium is important because our measure of exposure is
estimated using equity market data and, hence, if exposure is empirically related to the default premium in the manner expected, then
we can infer that the measure of exposure is valid in relation to examining whether exposure is priced.
To examine this, we first decompose each loan spread into an expected default loss premium and an expected return premium.11
The average loan spread is comprised of 41% default premium (about 78.5 basis points) and 59% expected return premium (111.3
basis points).
Estimating Eq. (2) for the default premium in loan spreads, the results in Model (1) of Table 3 indicate that the exposure coefficient
is 0.228 (t-statistic = 6.93). For a change from low exposure to high exposure for the average firm (from 0.13 to 2.30) this implies
around a 64% increase in default premium (100 × (exp[0.228 × 2.17]-1)), using the approach described in footnote 9. When applied to
the average default premium of 78.5 basis points, this would amount to an increase of about 50 basis points. The fact that exposure is
positively and significantly associated with the expected default loss premium not only validates our proxy, but it also informs us that
exposure elicits a substantial default premium.
We test the robustness of this result. We re-estimate the model for negative and positive exposures separately. The results, in Models
(2) and (3) of Table 3, continue to hold and show that the magnitude of the impact is similar for firms with positive and negative
exposures. In Model (4), we allow for positive and negative exposures to have a different impact on the default spread, while limiting
the control variables to take on the same value for all firms (increasing the power of the tests). The results are not substantially changed
from estimating the models separately. We also find that significant and insignificant exposures impact the default premium (Models 3
and 4 of Appendix 2), consistent with the finding that even when currency risk accounts for only a small proportion of the time-series
variation in stock returns, it nonetheless has a substantial influence on the overall risk premium (Maurer et al., 2019). The results are
also unchanged when we use double bootstrapped standard errors (see equivalent t-statistics in square brackets).
Finally, we posit that if the finding that exposure significantly impacts the expected default loss premium is not spurious, then we
would expect the impact of exposure on the expected default loss premium to increase with firm characteristics that are incrementally
informative to creditors about borrowers’ exposure and can further influence lenders’ perception of firms’ probability of default. We
also expect that loan characteristics that mitigate creditors’ loss given (currency-induced) default should reduce the impact of exposure
on the default premium. We hypothesize that internationalization, the ratio of firms’ foreign revenue to domestic revenue, increases
exposure’s impact on the default premium because it is one of the main causes of higher exposure and is easily observable by creditors.
Internationalization could have this effect because there is empirical evidence of a non-monotonic relation between internationali
zation and bond yield spread, where the two are inversely related at lower levels, but are positively related after internationalization
reaches a certain threshold. The underlying argument is that greater internationalization causes higher agency and bankruptcy costs,
which would result in the adverse effect of higher internationalization on the yield spread (see Mansi and Reeb (2002) and references
therein). Since agency and bankruptcy costs are firm-specific risks, they should contribute to the expected default loss premium in the
yield spread (observe that Mansi and Reeb (2002) do not decompose yield spread). Hence, we conjecture that internationalization
exacerbates the impact of exposure on the default premium.
We also hypothesize that the impact of exposure on the default premium increases with growth opportunities (proxied by the
market-to-book ratio). A possible reason for this is that, in periods with more growth opportunities and, consequently, higher demand
10
It is not likely that the insignificant exposure means that borrowers have effectively hedged away their exposure to currency risk. If so, banks
would not impose a material incremental loan charge and nonprice loan terms on account of exposure, consistent with the evidence in Campello
et al. (2011) that hedging reduces loan cost.
11
We follow the procedure detailed in Campello et al. (2011), derived from Cooper and Davydenko (2007). A subset of our initial sample was not
decomposed because of missing required data or failure to successfully converge. Given the similarity of the distributions of the full and decomposed
samples, we apply summary statistics of the decomposed subset to the full sample in discussing the effects of exposure on expected return and
default premia.
9
Table 3
Effect of exposure on expected default risk premium.
(1) (2) (3) (4)
All exposures Negative exposures Positive exposures All exposures
Absolute exposure 0.228***

OLS t-statistic (6.929)
Double bootstrap t-statistic [12.949]
Exposure − 0.234*** 0.207*** − 0.238***

OLS t-statistic (− 4.850) (3.303) (− 5.818)
Double bootstrap t-statistic [− 8.775] [4.914] [− 8.424]
Actual exposure×Pos exposure dummy 0.444***

OLS t-statistic (6.655)
Double bootstrap t-statistic [11.345]
Positive exposure dummy − 0.056

(− 0.497)
Control variables Yes Yes Yes Yes
Firm, year, loan type & purpose FE Yes Yes Yes Yes
Observations 24,142 12,846 11,296 24,142

Clusters (firms) 3779 3017 2903 3779
Adj. R2 0.565 0.603 0.612 0.565
This table reports results from ordinary least squares in which the dependent variable is the natural log of the expected default loss premium in loan
spread. All variables are defined in Appendix 1. The (t-statistics) in parentheses are based on robust standard errors that are corrected for firm-level
clustering. The [t-statistics] in square brackets are based on double bootstrapped standard errors. *, **, and *** represent significance at the 10, 5, and
1% levels based on the robust standard errors.
for cash to finance investment, currency-induced cash flow volatility exacerbates the potential loss of firms’ net worth due to the high
underinvestment cost (He and Ng, 1998). Additionally, we hypothesize that relationship lending increases exposure’s impact on the
default premium by mitigating information asymmetries between banks and borrowers about borrowers’ potential exposure. Finally,
we hypothesize that although riskier loans are typically the ones collateralized, the impact of exposure on the default premium is
expected to be lower for secured loans. We augment the model in Eq. (2) with these variables (where previously excluded) and their
interactions with exposure (one at a time). The results, in Table 4, indicate that all four interaction terms are significant. As predicted,
we find that internationalization, growth opportunities, and bank relationship increase the impact of exposure on the default premium,
while the effect is less for secured loans. The individual results are revealing. Model (1) indicates that even when firms are not
internationalized (as captured by our measure), exposure has a substantial effect on the expected default loss premium. From Model
(2), it is apparent that even at the minimum level of growth opportunities in our sample (0.798 from Table 1) exposure has a material
effect (12.4%) on the default premium. Model (3) suggests that banks rely on relationship lending to determine the potential impact of
exposure on the default premium as arms-length loans are not charged a default premium on account of exposure (although the co
efficient on the standalone exposure is positive and of reasonable magnitude). Finally, in Model (4), even secured loans are charged a
default premium, albeit much smaller than that on unsecured loans, perhaps because exposure might not only diminish borrowers’
capacity to service their loans, but also erode the value of the collateral.
4.3. Is exchange rate risk priced?
Having validated our measure of exposure, if currency risk is priced then the coefficient on exposure, δ, in Eq. (2) should be positive
and statistically significant when the dependent variable is the expected return premium. The results of this model are reported in
Model (1) of Table 5. They indicate that the exposure coefficient is negative and insignificant. This means that we fail to find that
currency risk is priced. Stated differently, we do not find evidence that exposure contributes to the “true” cost of debt of individual U.S.
firms. Estimating Eq. (2) using negative and positive exposures separately (Models 2 and 3) does not lead to a different inference. In
Model (4), we again allow for positive and negative exposures to have a different impact on the expected return premium. The results
are not substantially different from those when we estimate the models separately. We also estimate Eq. (2) based on the significance of
the exposures. Importantly, the evidence indicates that exposure is not related to the expected return premium for either the insig
nificant or significant exposures (Models 5 and 6 of Appendix 2). As the significant exposures are on average larger, and likely esti
mated with more precision (less noise), these are the strongest results yet indicating that exposure is not priced. The results are also
qualitatively unchanged when we use double bootstrapped standard errors (see equivalent t-statistics in square brackets).
It is important to note that the absence of evidence that currency risk is priced is not necessarily proof that no relation exists
between exposure and expected return premium, as we do not know the risk of a type II error. However, the estimated price of currency
risk is both very small and of the wrong expected sign, indicating that exposure is not likely of importance to banks when determining
10
Table 4
Characterizing exposure’s impact on the default premium.
(1) (2) (3) (4)
Absolute exposure 0.146*** − 0.007 0.056 0.395***

(2.744) (− 0.098) (1.390) (7.916)
Absolute exposure × internationalization 0.125***
(3.084)
Absolute exposure × market-to-book 0.147***
(3.789)
Absolute exposure × relationship dummy 0.333***
(6.358)
Absolute exposure × secured loan dummy − 0.294***
(− 4.735)
Internationalization − 0.314***
(− 2.952)
Secured loan dummy 0.752***
(5.388)
Observations 15,160 24,147 24,142 24,142

Clusters (firms) 2697 3779 3779 3779
Adj. R2 0.600 0.566 0.566 0.567
This table reports results from ordinary least squares in which the dependent variable is the natural log of the expected default loss premium. All
variables are defined in Appendix 1. The t-statistics, below the coefficients, are based on robust standard errors that correct for firm-level clustering. *,
**, and *** represent significance at the 10, 5, and 1% levels based on the robust standard errors.
Table 5
Tests of the pricing of exchange rate risk.
(1) (2) (3) (4)
All exposures Negative exposures Positive exposures All exposures
Absolute exposure − 0.002

OLS t-statistic (− 0.203)
Double bootstrap t-statistic [− 0.319]
Exposure − 0.006 0.000 0.001

OLS t-statistic (− 0.551) (0.010) (0.099)
Double bootstrap t-statistic [− 0.846] [0.010] [0.173]
Actual exposure×Pos exposure dummy − 0.005

OLS t-statistic (− 0.338)
Double bootstrap t-statistic [− 0.515]
Positive exposure dummy − 0.021

(− 1.110)
Observations 24,142 12,846 11,296 24,142

Clusters (firms) 3779 3017 2903 3779
Adj. R2 0.646 0.677 0.689 0.646
This table reports results from ordinary least squares in which the dependent variable is the natural log of expected return premium in loan spread. All
variables are defined in Appendix 1. The (t-statistics) in parentheses are based on robust standard errors that are corrected for firm-level clustering.
The [t-statistics] in square brackets are based on double bootstrapped standard errors. *, **, and *** represent significance at the 10, 5, and 1% levels
based on the robust standard errors.
their expected return on a loan.
4.4. Additional robustness tests
4.4.1. Addressing potential endogeneity

As we discussed in Section 3.2, by obtaining the expected return premium in loan spreads, estimating exposure prior to the loan
commencement date, and accounting for standard loan pricing factors such as term and default spreads, as well as including firm fixed
11
effects in all our models, we believe that our results are not plagued by endogeneity. Nonetheless, we take additional steps to address
this possibility.
First, we re-examine the fixed effects. Although controlling for several fixed effects is standard in the loan pricing literature, adding
loan “type” and “purpose” fixed effects to the usual firm and year fixed effects may affect the relation between exposure and loan
spreads. Consequently, in robustness tests, reported in Panels A-C of Appendix 3, we report results that include (a) neither the firm nor
year fixed effects (Model 1), (b) the year fixed effects only (Model 2), (c) the firm fixed effects only (Model 3), and (d) both firm and
year fixed effects (Model 4), but in all cases omit the loan type and purpose fixed effects. The results are broadly consistent with our
previous findings.12
Given that firms wary widely in the number of loans they obtain, as well as the spacing of the loans, one concern is that the results
could be driven by a few firms with many loans. We address this concern by re-estimating our main models for firms with 10 or fewer
loans. The results, presented in Panel D of Appendix 3, are qualitatively unchanged, although the coefficients are smaller in magnitude,
suggesting that the effect of exposure is stronger for firms with a large number of loans.
Second, all our loan pricing models include variables that we believe, a priori, would be most likely to simultaneously affect loan
spreads and exposure, such as leverage, profitability, and cash flow volatility.
Third, we augment our models with two additional variables that are not typically included in loan pricing models, but which could
simultaneously affect exposure and loan spreads. One variable is product market competition, which affects exposure (Luehrman,
1990; Bergbrant et al., 2014) and loan spreads (Valta, 2012). The other variable is changes in bank lending standards as Bergbrant et al.
(2014) finds that firm-level exposure increases with firm-level credit constraints and Bergbrant and Hunter (2018) finds that bank
lending standards increase aggregate exchange rate exposure. The results, reported in Models (1) to (4) of Table 6, indicate that
exposure continues to affect the default premium, but not the expected return premium.
Fourth, we estimate a 2SLS model to address general sources of endogeneity. We instrument each firm’s exposure with the exposure
of the firm’s Fama-French 49 industry portfolio exposure. As these exposures are expected to be correlated, the instrument meets the
relevance criterion. To ensure that we do not overstate the relevance of the instrument in the first stage of the 2SLS, when constructing
the instrument for a given firm’s exposure, we exclude the firm whose industry exposure we estimate. However, it is not likely that
lenders consider a borrower’s industry exposure when setting loan terms for the particular borrower and, hence, the industry exposure
would affect loan terms only through the individual firm’s exposure. This is because banks have unrivaled access to information about
a specific borrower’s various sources of exposure. On the other hand, a lender does not observe a borrower’s industry exposure.
Consequently, the instrument satisfies the exclusion restriction. We include firm fixed effects in both the first and second stages to
obtain a consistent estimate of the coefficient on exposure in the second-stage model. The results, reported in Table 6, indicate that the
instrument is highly significant (Model 5). From the second-stage model (Models 6 and 7) the evidence indicates that exposure affects
the expected default risk premium, but not the expected return premium.
4.4.2. Time-varying price of risk

Consistent with the evidence of time variation in the price of currency risk and the observation that the currency risk premium is
larger during volatile macroeconomic conditions (De Santis and Gerard, 1998; Williamson, 2001; Francis et al., 2008), we allow the
impact of exposure in Eq. (2) to vary with currency and equity market conditions. Specifically, we interact exposure with the standard
deviation of changes in the Broad currency index (FXVol, estimated over the same time period that exposure was estimated for each
firm-loan) and equity market implied volatility (VIX, recorded at the time of the loan). The results are reported in Models (1) and (2) of
Panels A-C of Table 7. They indicate that the loan spread and expected default loss premium increase with currency and equity market
volatility, while the expected return premium only increases with the former. For loan spread and its components, the significant
interactions are negative, while the standalone exposure variables are positive. These results suggest that lenders directly impound
market conditions in loan spread and the importance of exposure diminishes when markets are volatile.
Importantly, the loan spread and the expected default loss premium are both positively related to exposure at any reasonable level
of exchange rate volatility (i.e., exposure + exposure × FXVol (or VIX) are positive at any reasonable level of FXVol (or VIX)). However,
for the expected return premium (Panel C of Table 7), when evaluated at reasonable values of FXVol, the relation between exposure and
expected return is generally negative. In particular, when we evaluate the impact of exposure at the average level of FXVol (which is
0.006), the resulting impact of exposure on the expected return premium is negative (0.058 + 0.006 × − 10.142 = − 0.0029) but very
close to 0. In order for exposure to have a positive impact on the expected return premium, we would have to evaluate its impact at very
low levels of FXVol and, even at those levels, the magnitude of the impact is very small. For example, evaluating the impact at the
lowest observed value of FXVol (0.003), the model suggests an increase in the expected risk premium of 0.028 (0.058 + 0.003 ×
− 10.142 = 0.028) per unit increase in exposure. Hence, although the model suggests a significant relation between exposure and the
expected return premium, it returns a currency risk premium that is either very small (when evaluated at very low levels of currency
volatility) or negative (when evaluated at more common levels of currency volatility).
4.4.3. Other currency factors

In this section we address the concerns that our (Broad) trade-weighted currency index is not specifically designed to allow het
erogeneity in exposure across firms or capture the systematic effect of exchange rate changes and, therefore, could underestimate the
12
Omitting year fixed effects gives rise to a currency risk discount in the expected return premium (see, also, Section 4.4.3). This likely reflects
time variation in currency risk premium and, therefore, including time fixed effects is important.
12
Table 6
Addressing potential endogeneity.
(1) (2) (3) (4) (5) (6) (7)
Exp. default Exp. return Exp. default Exp. return 1st stage exposure 2nd stage exp. 2nd stage exp.
premium premium premium premium - both models default premium return premium
Competition Lending standards 2SLS
Absolute exposure 0.214*** 0.001 0.227*** − 0.002

(6.550) (0.121) (6.900) (− 0.225)
Competition 0.035 0.003
(1.061) (0.478)
Bank lending 0.006 0.001
standards
(1.423) (1.320)
Instrument 0.361***
(9.229)
Predicted abs. 0.688*** 0.026
exposure
(2.620) (0.528)
Control variables Yes Yes Yes Yes Yes Yes Yes
Firm, year, loan type Yes Yes Yes Yes Yes Yes Yes
& purpose FE
Observations 22,758 22,758 24,142 24,142 23,985 23,985 23,985

Clusters (firms) 3573 3573 3779 3779 3739 3739 3739
Adj. R2 0.561 0.647 0.565 0.646 0.366 0.557 0.644
The dependent variables are the natural log of the components of loan spread at the top of each column, except for Model (5) where it is the absolute
exposure. We control for competition (Models 1 and 2) and bank lending standards (Models 3 and 4). In Models (5) to (7) we estimate a 2SLS model
using each firm’s (value weighted) industry exposure to instrument for the firm’s exposure (in Model 5). The control variables are those reported in
prior tables. All variables are defined in Appendix 1. The t-statistics, below the coefficients, are based on robust standard errors that correct for firm-
level clustering. *, **, and *** represent significance at the 10, 5, and 1% levels based on the robust standard errors.
price of exchange rate risk.

First, we use alternative trade-weighted currency indices (Major and OITP) and change the model for estimating exposure by
augmenting Eq. (1) with the Fama-French factors which, by including these additional factors, could reduce potential confounding
effects that may understate the effect of the currency index.13 The results, reported in Appendix 4, remain qualitatively similar to those
reported above.
Second, we re-estimate exposure using changes in the bilateral exchange rates of individual currencies, specifically the Canadian
dollar, the Euro, and the Mexican peso against the U.S. dollar. Together, these markets account for close to 50% of U.S. trade. The only
other country that accounts for more than 6% of trade is China, but the Chinese currency is pegged to the dollar, so we do not include it
in the exposures. Model (3) of Panels A-C of Table 7 replicates our main models (for the loan spread and its components) when the
exposures to the individual currencies are jointly estimated and are simultaneously included in Eq. (2).14 Exposure to all three cur
rencies is significantly related to the loan spread (Panel A) and the expected default loss premium (Panel B). Corroborating the prior
findings, the exposures to individual currencies are not significant in the models for the expected return premium (Panel C).
Finally, we estimate exposure with respect to the Carry, Dollar, and three other exchange rate factors developed by LRV (2011,
2014) and Verdelhan (2018) to capture the common variation in many currencies. The results are reported in Models (4) to (6) of
Panels A-C of Table 7. They are qualitatively similar to our previous findings in that while an economically large and statistically
significant component of loan spread is attributable to currency risk, its impact is only on the expected default loss premium. Using
these alternative currency factors, we unearth no evidence that currency risk contributes an economically meaningful risk premium to
the expected return premium in loan spread. In fact, there is a small and significant currency risk discount related to the RX and
DOLLAR factors, consistent with the evidence in Karolyi and Wu (2021) for stock portfolios.
4.4.4. Nonlinear effect of exposure

Two defining features of the private debt markets are the infrequency with which firms take loans and the possible selection of firms
that ultimately obtain loans. Since we can only observe the loans that are provided to firms, it is possible that the sample used in our
analysis is biased, as firms with high exposure might not be able to access the private debt market. Although it would be advantageous
to create a selection model to account for this, creating such a model is challenging as we do not observe loans at regularly spaced
intervals (over our 23-year sample period, 56% of the firms in our sample have four or fewer loans, while 81% of firms have 10 or fewer
13
To the extent that the Fama-French factors are related to financial distress, accounting for them in Equation (1) could result in the changes in the
currency index being more representative of the systematic component of currency risk.
14
The results also hold when we estimate exposure to each currency separately.
13
Table 7
Market conditions, alternative currency factors, and exposure.
Panel A: Loan spread
(1) (2) (3) (4) (5) (6)
Interaction Interaction Individual Lustig et al. (2011, 2014; hereafter LRV (2014) Verdelhan
with FXVol with VIX Currencies LRV (2011) and LRV (2014) Currency factor (2018)
Currency factors Currency
factors
Absolute exposure 0.066*** 0.047***

(4.483) (3.999)
FXVol (or VIX) 39.326*** 0.003***
(5.299) (3.121)
FXVol (or VIX) × − 6.848*** − 0.001**
Exposure
(− 2.838) (− 1.970)
Abs_CAD_Market- 0.023***
augmented
(3.822)
Abs_EUR_ Market- 0.031***
augmented
(3.214)
Abs_MEX_ Market- 0.035***
augmented
(4.021)
HMLFX 2.766***
(2.687)
RX 1.865**
(2.041)
USD 6.001***
(5.881)
CARRY 3.372***
(3.641)
DOLLAR 2.050***
(3.032)
Control variables Yes Yes Yes Yes Yes Yes

Firm, year, loan type & Yes Yes Yes Yes Yes Yes
purpose FE
Observations 32,035 32,035 32,035 27,920 27,920 27,920

Clusters (firms) 4436 4436 4436 3945 3945 3945
Adj. R2 0.723 0.722 0.723 0.728 0.729 0.728
Panel B: Expected default loss premium
(1) (2) (3) (4) (5) (6)
Interaction with Interaction Individual LRV (2011) Lustig et al. (2011, 2014; hereafter Verdelhan
FXVol with VIX Currencies Currency factors LRV (2011) and LRV (2014) (2018)
Currency factor Currency
factors
Absolute exposure 0.493*** 1.007***

(5.141) (10.445)
FXVol (or VIX) 293.513*** 0.070***
(4.565) (8.204)
FXVol (or VIX) × − 43.329*** − 0.038***
Exposure
(− 2.745) (− 9.398)
Abs_CAD_Market- 0.232***
augmented
(5.210)
Abs_EUR_Market- 0.402***
augmented
(4.854)
Abs_MEX_Market- 0.386***
augmented
(5.397)
HMLFX 51.321***
(continued on next page)
14
Table 7 (continued )
(1) (2) (3) (4) (5) (6)
Interaction with Interaction Individual LRV (2011) Lustig et al. (2011, 2014; hereafter Verdelhan
FXVol with VIX Currencies Currency factors LRV (2011) and LRV (2014) (2018)
Currency factor Currency
factors
(6.945)
RX 52.881***
(7.444)
USD 61.931***
(8.202)
CARRY 65.071***
(8.623)
DOLLAR 36.961***
(6.935)
Firm, year, loan type & Yes Yes Yes Yes Yes Yes
purpose FE
Observations 24,142 24,142 24,142 23,436 23,436 23,436

Clusters (firms) 3779 3779 3779 3683 3683 3683
Adj. R2 0.566 0.569 0.567 0.572 0.570 0.574
Panel C: Expected return premium
(1) (2) (3) (4) (5) (6)
Interaction with Interaction with Individual LRV (2011) LRV (2014) Verdelhan
FXVol VIX Currencies Currency Currency (2018)
factors factor Currency factors
Absolute exposure 0.058** 0.019

(2.519) (0.962)
FXVol (or VIX) 32.890*** 0.001
(2.979) (0.857)
FXVol (or VIX) × Exposure − 10.142*** − 0.001
(− 2.682) (− 1.080)
Abs_CAD_Market-augmented − 0.007
(− 0.704)
Abs_EUR_Market-augmented − 0.016
(− 0.960)
Abs_MEX_Market-augmented − 0.004
(− 0.273)
HMLFX − 2.206
(− 1.356)
RX − 5.066***
(− 3.638)
USD − 0.680
(− 0.449)
CARRY − 2.568*
(− 1.755)
DOLLAR − 2.900***
(− 2.677)
Firm, year, loan type & purpose Yes Yes Yes Yes Yes Yes
FE
Observations 24,142 24,142 24,142 23,436 23,436 23,436

Clusters (firms) 3779 3779 3779 3683 3683 3683
Adj. R2 0.646 0.646 0.646 0.649 0.648 0.648
This table reports results from ordinary least squares in which the dependent variable is the natural log of the loan spread in Panel A, expected default
loss premium in Panel B, and expected return premium in Panel C. All variables are defined in Appendix 1. The t-statistics, below the coefficients, are
based on robust standard errors that correct for firm-level clustering. *, **, and *** represent significance at the 10, 5, and 1% levels based on the
robust standard errors.
15
loans). Hence, few firms in the cross-section received a loan in any given period. Although our sample is comprised of firms that were
successful in obtaining loans despite having a wide range of exposures (0.00 to 4.28), suggesting that the selection issue may be muted,
it is still possible that the impact of exposure on the expected return premium is understated if the relation between exposure and the
expected return premium is nonlinear. Specifically, if the relation between exposure and the expected return premium is stronger for
firms with larger exposures, the impact of exposure might be understated if the firms with the highest exposures are excluded from the
sample. Although not a substitute for a selection model, we conjecture that if the relation between exposure and the expected return
premium is more pronounced for high exposures, we should find evidence of such in our current sample. That is, unless exposure is
related to loan spread only at very high levels of exposure, we can analyze whether larger exposures have a more pronounced impact on
loan spreads than smaller exposures in our current sample. In Appendix 5, we take the natural log of the absolute exposures or square
root of the absolute exposures, and analyze the impact on loan spread and its components. If only large exposures matter, then we
would expect that these models would produce much less significant exposure parameters as well as less explanatory power for the
model overall. This is because taking the log or square root reduces the impact of large exposures. Given the similarity in both the
significance of the coefficients and the adjusted r-squares across the models (for example, comparing Model (4) in Table 2 to Models (1)
and (2) in Appendix 5), it does not appear that large exposures are disproportionally more important. We also include the squared level
of exposure in Model (3) (Model (6) for the expected default loss premium and Model (9) for the expected return premium). Inter
estingly, Model (6) shows a negative and significant coefficient on the squared exposure, implying that exposure is less related to the
default premium at higher levels of exposure.
Importantly, the relation between exposure and the expected return premium is not significant using either of the alternate rep
resentations of exposures (Models 7 and 8), or the squared exposure (Model 9). All considered, we do not believe that the absence of
high exposure firms from our sample materially impacts our findings.
5. Does exposure affect nonprice loan terms?
In Table 8, we report results from various models of nonprice loan terms on exposure.15 In Model (1) of Panel A, we estimate the
effect of exposure on the probability of pledging collateral using a probit model. The exposure coefficient is 0.078 (t-statistic = 4.0),
implying that exposure increases the probability that the loan is secured. In Model (2), where we estimate exposure’s effect on loan
maturity, the exposure coefficient is − 0.014 (t-statistic = 2.94), implying that if the average firm’s exposure changed from low to high,
loan maturity would decline by about one and a half months, relative to an average of approximately 49 months. In Models (3 to 5), we
provide evidence that exposure affects syndicate structure. While exposure is not associated with syndicate concentration, measured
by a Herfindahl Hirschman index (Model 3), it is inversely related to foreign lender share (the portion of the loan that is funded by
foreign lenders). We find that changing from low exposure to high exposure reduces the foreign lender share for the average firm by
approximately 1.6 percentage points, relative to the mean foreign lender share of about 40%. Although not as we originally hy
pothesized, this is consistent with the notion that firms with shocks to their exposure might rely on fewer lenders in total and place
greater reliance on their domestic (home country) lenders to reduce possible loan restructuring costs (Bolton and Scharfstein, 1996;
Lee and Mullineaux, 2004). Finally, the evidence also indicates that the probability that foreign syndicate members are the main
supplier of credit (Model 5) decreases with exposure. These results are consistent with the interpretation that exposure reduces foreign
lender participation.
In Panel B of Table 8, we use (the natural log of) fees as proxies for banks’ screening and monitoring of borrowers. Although not all
fees are significant, they are all positive, indicating that an increase in exposure increases the fees associated with the loans. In Model
(2), a change in exposure from low to high is associated with an 8% increase in the annual fee from an average of 16.6 basis points,
adding about $280,000 in expenses over the life of the average loan.16 Similarly, we find that the above increase in exposure is
associated with a 5.1% increase in standby fee (Model 4). We also find that exposure is associated with a marginally significant increase
in the number of financial covenants.
6. Summary and conclusions
We use the unique features of bank loan contracts to identify the channels through which exchange rate risk impacts individual
firms. Our results indicate that banks take account of borrowers’ exchange rate exposure in setting loan spreads as exposure is both
economically and statistically related to loan spreads. Decomposing loan spreads, we fail to find evidence that exchange rate risk is
priced as exposure does not impact the expected return premium in loan spreads and, therefore, does not affect the “true” cost of debt
in any meaningful way. Instead, exposure has an economically large impact on the expected default risk premium, suggesting that
currency risk has a diversifiable, cash-flow effect, which increases the risk of default. Further, we find that exposure is associated with
more intense monitoring, greater financial covenant intensity, higher likelihood of pledging collateral, and shorter loan maturity on
average.
15
The number of observations vary widely across the nonprice models due to DealScan data limitations. Moreover, due to limited within-firm
variation in the “foreign majority” funding variable in Model (5) of Panel A of Table 8, and the use of firm fixed effects, the finding is driven by
a small number of firms and should be interpreted with caution.
16
The annual fee [increase in fee × mean fee × mean loan size × mean maturity in years] is based on mean loan of $643,352,900 and maturity of
39.3 months for only those firms with annual fees.
16
Table 8
Exposure and nonprice loan terms.
Panel A: Access and Syndicate Structure
(1) (2) (3) (4) (5)
Prob(Secured Ln(Loan Syndicate Foreign Prob(Foreign majority lender share

loan) maturity) concentration lender >50%)
share
Absolute exposure 0.078*** − 0.014*** 66.597 − 0.740* − 0.182***

(3.998) (− 2.938) (1.499) (− 1.726) (− 2.842)
Control variables Yes Yes Yes Yes Yes
Firm, year, loan type & purpose Yes Yes Yes Yes Yes
FE
Marginal effects (probit models) 0.0199 − 0.0523

(4.005) (− 2.834)
Observations 20,341 32,035 7980 7980 1707
Clusters (firms) 1878 4436 2821 2821 333
Adj./Pseudo R2 0.345 0.374 0.768 0.691 0.235
Panel B: Monitoring and Covenant Intensity
(1) (2) (3) (4) (5) (6) (7)
Ln(Upfront Ln(Annual Ln(Commitment Ln(Standby No. of general No. of financial Total no. of
fee) fee) fee) fee) covenants covenants covenants
Abs. exposure 0.040 0.035*** 0.010 0.023*** − 0.010 0.014* 0.009

(1.538) (2.921) (1.483) (2.832) (− 0.699) (1.734) (1.233)
Control variables Yes Yes Yes Yes Yes Yes Yes
Firm, year, loan type & Yes Yes Yes Yes Yes Yes Yes
purpose FE
Observations 6882 6061 12,924 8692 32,035 32,035 32,035

Clusters (firms) 2514 1486 3690 3132 4436 4436 4436
Adj./Pseudo R2 0.493 0.796 0.605 0.628 0.410 0.221 0.254
The dependent variables are nonprice loan terms stated at the top of each column. In Panel A, Models (1) and (5) use probit models to estimate the
probability of pledging collateral (Secured loan dummy) and that more than half of the loan is funded by foreign lenders (Foreign majority lender
share). Models (2), (3), and (4) estimate loan maturity, syndicate concentration, and foreign lender share of the loan with ordinary least squares. In
Panel B, the dependent variables are the natural log of loan fees in Models (1) to (4), estimated with ordinary least squares, and the number of
covenants in Models (5) to (7), estimated with Poisson models. All variables are defined in Appendix 1. The t-(z-) statistics, which are below the
coefficients, are based on robust standard errors that correct for firm-level clustering. *, **, and *** represent significance at the 10, 5, and 1% levels
based on the robust standard errors.
There are two important practical implications of our findings for corporate executives. First, managers of U.S. firms should not
adjust their firm’s cost of debt to account for a currency risk premium. Existing survey-based evidence indicates that firms modify the
discount rate used in capital budgeting to account for currency risk (Graham and Harvey, 2001). However, combining our finding with
the absence of robust firm-level evidence that currency risk is priced in stock returns suggests that it may not be necessary to adjust the
WACC for a currency risk premium. This has implications not only for the evaluation of capital budgeting projects, but also for
performance evaluation, regulatory intervention, valuation, and other decisions where the cost of capital plays a crucial role.
Second, (highly) leveraged firms with even modest currency exposure should consider hedging currency risk with the clear motive
of reducing the expected default premium and the costs of nonprice loan terms. Though inconsistent with perfect-market theories,
friction-based theories posit that cash-flow hedging can create value (Smith and Stulz, 1985; Froot et al., 1993). This is supported by
recent surveys indicating that risk managers hedge to reduce cash flow volatility (Giambona et al., 2018). However, firms should
carefully consider the tradeoff between the cost of more intensive hedging and higher loan costs and should prioritize (cheaper)
operating hedges over costlier financial hedges where practical.
Our results could be a motivation for future work. In particular, future work can examine whether these results are generalizable
globally; specifically, whether exchange rate exposure is priced in the expected return premium of a global portfolio of bank loans and
if the magnitude of exposure’s impact on the expected default loss premium varies in a predictable manner across countries. It is likely
that our U.S.-based results are influenced by a combination of pricing in U.S. dollars (Goldberg and Tille, 2008; Gopinath et al., 2020),
extensive currency risk hedging (Bartram et al., 2010), and possibly the use of earnings management (Chang et al., 2013). In contrast,
the expected return premium in loans to non-U.S. firms may be more likely to embed a currency risk premium given recent evidence by
17
Karolyi and Wu (2021) that currency risk is priced in the cross-section of global returns, but this critically depends on including firms
from emerging markets. In addition, future work could account for the possibility that bank competition (Boot and Thakor, 2000),
bank distress (Santos and Winton, 2019), and zombie lending (Caballero et al., 2008) influence the extent to which banks embed the
true level of exchange rate risk in loan spreads.
Appendix 1 Data description.
Variable Data Description
Dependent variables
Loan spread All-in spread drawn that the lender charges over LIBOR on the amount drawn by the borrower, reported by DealScan
Expected default risk premium Compensation for expected default loss in loan spread, obtained from decomposing spread as per Cooper and Davydenko
(2007)
Expected return premium Compensation for systematic risk in loan spread (i.e., loan spread-expected default loss premium), which is the cost of bank
debt
General covenant Restriction on dividends, sweep, and net worth in loan contract
Financial covenant Restrictions on financial ratios (e.g., debt restrictions, liquidity restrictions, or operating income restrictions) in the loan
contract
Number of (foreign) lenders Total number of lenders (foreign lenders) funding the loan
Syndicate Concentration The Herfindahl Hirschman index of loan shares (the proportion of the funding of the loan) by lenders within a syndicate for
the loans for which the “BankAllocation” variable is reported in DealScan
Proportion of the funding of the loan (loan share) that is allocated to foreign lenders for the loans that have data for the
Foreign lender share
“BankAllocation” variable in DealScan
Equal one if the sum of foreign lenders’ loan shares is greater than 50% of the total funding for the loan, for loans that have
Foreign majority lender share
data for the “BankAllocation” variable in DealScan
Upfront fee Natural log of the one-time fee paid by the borrower at the time of the closing of the loan (in basis points)
Annual (or facility) fee Natural log of an annual charge as a percentage of the original loan commitment, whether used or unused (in basis points)
Natural log of fee on unused loan commitment in credit lines. Loans typically do not contain both annual and commitment
Commitment fee
fees
Independent variables
Coefficient on exchange rate changes in regression of a firm’s stock returns on changes in the Broad exchange rate index and
CRSP value-weighted stock market returns (Broad market-augmented; Eq. 1), using 52 weekly observations ending 4 weeks
Exposure
prior to the loan. Other exposures are obtained by (i) adding Fama-French factors, (ii) using the Major or OITP index, or (iii)
using bilateral exchange rates between the dollar and the Canadian dollar (CAD), Mexican peso (MEX), and euro (EUR)
Lustig et al. (2011) factors: (a) Dollar Risk Factor (RX), an equally weighted average dollar return for a U.S. investor that
takes a long position in all non-U.S.-dollar currencies that have forward rates; (b) Carry Trade Risk Factor (HMLFX), the
return in dollars on a zero-cost strategy that goes long in high interest rate currencies and short in low interest rate
RX and HMLFX (LRV, 2011)
currencies for currencies that have forward rates. Factors are monthly and exposure is estimated using four years of data one
month prior to the loan date (data by Karolyi and Wu (2021) at https://academic.oup.com/rof/article/25/3/863/
5917643#supplementary-data)
Lustig et al. (2014) factor: Dollar Carry-Trade (USD), excess returns on an investment strategy that goes long all available 1-
month-ahead currency forward contracts when the average forward discount of developed countries is positive, and it goes
USD (LRV, 2014)
short the same contracts, otherwise (the data are provided by Karolyi and Wu (2021) and are available at: https://academic.
oup.com/rof/article/25/3/863/5917643#supplementary-data)
The Verdelhan (2018) factors, constructed from six portfolios of currencies that are sorted by their level of interest rate,
where (a) Carry Factor (CARRY) is the average change in exchange rate between countries in the portfolio of currencies with
the highest interest rates and those in the portfolio of currencies with the lowest interest rates or (b) Dollar Factor
CARRY and DOLLAR (Verdalhen,
(DOLLAR), which is the average of the time series of changes in exchange rates for the six currency portfolios. The factors are
2018)
monthly and exposure is estimated using four years of data up to one month prior to the loan date. The data is provided as
supplementary data by Karolyi and Wu (2021) and is available at: https://academic.oup.com/rof/article/25/3/863/
5917643#supplementary-data
Trade-weighted index of bilateral exchange rates between the USD and (a) 7 major currencies that trade freely outside of
Major or OITP index their country of issue or (b) 19 currencies of developing countries that are “other important trading partners;” in foreign
currency/USD
Broad index Combines currencies in both the Major and the OITP indices above
Control variables
Firm size Natural log of total assets (AT), $m
Market-to-book Market value of equity plus the book value of debt divided by total assets
Leverage Sum of long-term debt (DLTT) and debt in current liabilities (DLC) divided by total assets (AT)
Profitability Operating income before depreciation (OIBDP) divided by total assets (AT)
Tangibility Net property, plant, and equipment (PPE) divided by total assets (AT)
Modified Altman’s Z-score computed as ((1.2*working capital (WCAP) + 1.4*retained earnings (RE) + 3.3*EBIT +
Z-score
0.999*sales (SALE))/total assets (AT))
Cash flow volatility Standard deviation of 16 quarterly cash flows, using data up to and including the most recent fiscal quarter before the loan
Text-based competition based on grouping firms in industries with similar products. Competition (TSIMM) increases with
Competition (TSIMM)
competition. Data provided by Gerard Hoberg at http://hobergphillips.usc.edu/
(continued on next page)
18
(continued )
Variable Data Description
Bank lending standards A measure of bank credit conditions, represented by changes in bank lending standards for commercial and industrial loans
to large and middle-market firms, obtained from https://www.federalreserve.gov/data/sloos/sloos
Internationalization Foreign revenue/domestic revenue, where foreign revenue includes both export sales and revenue from foreign
subsidiaries. If foreign revenue is not available, we use foreign sales instead (based on data from Compustat Geographic
Segments)
Foreign currency revenue Sum of revenues from countries (exceeding 1% of sales) with currencies different from the U.S. dollar/total revenues (based
on data from FactSet Revere)
Foreign currency revenue Sum of the square of (total revenue derived from each foreign country with a currency different from the U.S. dollar/total
concentration amount of foreign revenue) based on data from FactSet Revere
Subsidiary_10K The total number of foreign subsidiaries that a firm has based on a search of Exhibit 21 of the 10-K
Subsidiary_countries_10K The total number of countries within which a firm has operations based on a search of Exhibit 21 of the 10-K
Currency_hedge_10K Number of currency hedging-related keywords in firm’s most recent 10-K/total number of words in 10-K (multiplied by
100)
General_hedge_10K Number of non-currency hedge-related keywords in most recent 10-K/total number of words in 10-K (multiplied by 100)
Loan maturity Natural log of the loan term in months
Loan size Natural log of facility amount, $m
Performance pricing dummy Equal one if loan contract contains performance pricing clause, and zero otherwise
Relationship dummy Equal one if the firm had a prior loan with the lead lender of the syndicate within the last 5 years, and zero otherwise.
Secured loan dummy Equal one if the loan is secured, and zero otherwise (same as collateral dummy)
Loan type dummy 2 loan type dummies equal one for term loans and credit lines, respectively, and zero otherwise
Loan purpose dummy 12 loan purpose dummies equal one for a loan for a particular purpose (e.g., working capital, debt repayment), and zero
otherwise
Default spread BAA corporate bond yield minus AAA corporate bond yield
Term spread 10-year Treasury yield minus 2-year Treasury yield
FXVol The standard deviation of the FX returns used to calculate the exposure for the firm-loan
VIX CBOE S&P500 Volatility Index as of the deal active date (if unavailable on “deal active date”, we use most recent value
available)
Appendix 2 Relation between loan spread and significant/insignificant exposures.
Loan spread Expected default premium Expected risk premium
(1) (2) (3) (4) (5) (6)
Signif. Insignif. Signif. Insignif. Signif. Insignif.
Absolute exposure 0.070** 0.034*** 0.972*** 0.222*** 0.028 0.001

OLS t-stat (2.564) (5.604) (5.284) (5.244) (0.707) (0.050)
Double bootstrap t-stat [3.093] [8.143] [7.208] [7.244] [1.004] [0.072]
Controls Yes Yes Yes Yes Yes Yes
Firm, year, loan type & purpose FE Yes Yes Yes Yes Yes Yes
Observations 4432 27,603 3418 20,724 3418 20,724

Clusters (firms) 1683 4283 1393 3639 1393 3639
Adj. R2 0.751 0.729 0.785 0.567 0.748 0.653
This table reports results from ordinary least squares in which the dependent variable is the natural log of the loan spread, expected default loss
premium, and expected return premium (in Columns 1–2, 3–4, and 5–6, respectively) for an individual loan. The independent variables of primary
interest are the significant and insignificant estimates of the Broad market-augmented exposure. All variables are defined in Appendix 1. The (t-
statistics) in parentheses below the coefficients are based on robust standard errors that correct for firm-level clustering. The [t-statistics] in square
brackets are based on double bootstrapped standard errors. *, **, and *** represent significance at the 10, 5, and 1% levels based on the robust
standard errors.
19
Appendix 3 Isolating fixed effects.

Panel A: Loan Spread
(1) (2) (3) (4)
Abs. exposure 0.048*** 0.057*** 0.021*** 0.025***

(9.822) (11.541) (4.182) (4.975)
Controls Yes Yes Yes Yes
Firm FE No No Yes Yes
Year FE No Yes No Yes
Loan Type & Purpose FE No No No No
Observations 32,035 32,035 32,035 32,035

Clusters (firms) 4436 4436 4436 4436
Adj./Pseudo R2 0.427 0.482 0.632 0.672
(1) (2) (3) (4)
Abs. exposure 0.564*** 0.532*** 0.258*** 0.225***

(18.787) (18.349) (7.208) (6.841)
Observations 24,142 24,142 24,142 24,142

Clusters (firms) 3779 3779 3779 3779
Adj./Pseudo R2 0.254 0.388 0.435 0.564
Panel C: Expected default loss premium
(1) (2) (3) (4)
Abs. exposure − 0.023*** 0.009 − 0.035*** − 0.001

(− 2.862) (1.147) (− 4.018) (− 0.118)
Observations 24,142 24,142 24,142 24,142

Clusters (firms) 3779 3779 3779 3779
Adj./Pseudo R2 0.198 0.383 0.508 0.619
Panel D: Subsample of firms with 10 or fewer loans
Loan Spread Expected default loss premium Expected return premium
Abs. exposure 0.014** 0.121*** − 0.010

(2.220) (2.704) (− 0.804)
Control variables Yes Yes Yes
Firm FE Yes Yes Yes
Year FE Yes Yes Yes
Loan Type & Purpose FE Yes Yes Yes
Observations 13,735 9286 9286

Clusters (firms) 4053 2987 2987
Adj./Pseudo R2 0.728 0.620 0.647
Panels A-C of this table reports results from ordinary least squares in which the dependent variable is the natural log of the loan spread,
expected default loss premium, and expected return premium, respectively, with each model containing different fixed effects. In Panel
D, only firms with 10 or fewer loans throughout the sample period are included. All models use the Broad market-augmented exposure.
All variables are defined in Appendix 1. The t-statistics, below the coefficients, are based on robust standard errors that correct for firm-
level clustering. *, **, and *** represent significance at the 10, 5, and 1% levels based on the robust standard errors.
20
Appendix 4 Estimates of exposure from different currencies and approaches.

Panel A: Loan Spread
Market-augmented Fama-French-augmented
(1) (2) (3) (4) (5)
Major OITP Broad Major OITP
Absolute exposure 0.036*** 0.018*** 0.023*** 0.035*** 0.020***

(5.354) (5.762) (5.261) (5.159) (6.060)
Firm, year, loan type & purpose FE Yes Yes Yes Yes Yes
Observations 32,035 32,035 32,035 32,035 32,035

Clusters (firms) 4436 4436 4436 4436 4436
Adj. R2 0.722 0.722 0.722 0.722 0.722
Panel B: Expected Default Loss Premium
(1) (2) (3) (4) (5)
Absolute exposure 0.363*** 0.145*** 0.223*** 0.355*** 0.141***

(7.207) (6.100) (6.874) (6.958) (6.089)
Observations 24,142 24,142 24,142 24,142 24,142

Clusters (firms) 3779 3779 3779 3779 3779
Adj. R2 0.565 0.565 0.565 0.565 0.564
Panel C: Expected Return Premium
(1) (2) (3) (4) (5)
Absolute exposure − 0.008 0.004 − 0.002 − 0.011 0.002

(− 0.714) (0.705) (− 0.277) (− 0.936) (0.368)
Observations 24,142 24,142 24,142 24,142 24,142

Clusters (firms) 3779 3779 3779 3779 3779
Adj. R2 0.646 0.646 0.646 0.646 0.646
This table reports results from ordinary least squares in which the dependent variable is the natural log of the loan spread, the expected default
premium, and expected return premium (in Panels A, B, and C, respectively) for an individual loan and the estimates of currency exposure are Major
and OITP market-augmented exposures (Models 1 and 2) and Fama-French-augmented exposures (Models 3 to 5). All variables are defined in Ap
pendix 1. The t-statistics, below the coefficients, are based on robust standard errors that correct for firm-level clustering. *, **, and *** represent
significance at the 10, 5, and 1% levels based on the robust standard errors.
21
Appendix 5 Nonlinear effect of exposure.

Loan Spread Expected default loss premium Expected return premium
(1) (2) (3) (4) (5) (6) (7) (8) (9)
Ln(Abs. exposure) 0.018*** 0.166*** 0.002

(5.035) (5.261) (0.306)
Sqrt(Abs. exposure) 0.054*** 0.512*** − 0.001
(5.441) (6.569) (− 0.072)
Abs. exposure 0.024* 0.453*** 0.002
(1.911) (4.185) (0.093)
Exposure2 0.000 − 0.062** − 0.001
(0.091) (− 2.372) (− 0.182)
Control variables Yes Yes Yes Yes Yes Yes Yes Yes Yes
Firm, year, loan type & purpose FE Yes Yes Yes Yes Yes Yes Yes Yes Yes
Observations 32,035 32,035 32,035 24,142 24,142 24,142 24,142 24,142 24,142
Clusters (firms) 4436 4436 4436 3779 3779 3779 3779 3779 3779
Adj./Pseudo R2 0.722 0.722 0.722 0.565 0.565 0.565 0.646 0.646 0.646
This table reports results from ordinary least squares in which the dependent variable is the natural log of the loan spread, expected default loss, and
expected return premium for an individual loan. The independent variables of primary interest are the natural log of the absolute exposure, the square
root of the absolute exposure, and the absolute exposure plus its squared value. All models use the Broad market-augmented exposure. All variables
are defined in Appendix 1. The t-statistics, below the coefficients, are based on robust standard errors that correct for firm-level clustering. *, **, and
*** represent significance at the 10, 5, and 1% levels based on the robust standard errors.
Data availability
Data will be made available on request.
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How Does Currency Risk Impact Firms - New Evidence From Bank Loan Contracts JCF 2024

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Journal of Corporate Finance 84 (2024) 102542

Contents lists available at ScienceDirect

Journal of Corporate Finance

2. Literature review and hypotheses development

2.1. Previous research

2.2. Hypotheses development

3. Data and methodology

3.1. Loan pricing data and controls

3.2. Measure of exchange rate exposure and empirical approach

Obs Mean Std Min Max

Panel B: Exchange Rate Exposure

Obs Mean Std Min Max

Ln(firm size) − 0.226 Foreign currency revenue 0.034

4.1. Effect of exposure on loan spreads

Absolute exposure 0.048*** 0.053*** 0.023*** 0.025*** − 0.021*** 0.036***

Firm FE No No Yes Yes Yes Yes

Observations 32,035 32,035 32,035 32,035 16,902 15,133

4.2. Does exposure affect the default premium?

All exposures Negative exposures Positive exposures All exposures

Absolute exposure 0.228***

Exposure − 0.234*** 0.207*** − 0.238***

Actual exposure×Pos exposure dummy 0.444***

Positive exposure dummy − 0.056

Observations 24,142 12,846 11,296 24,142

4.3. Is exchange rate risk priced?

Absolute exposure 0.146*** − 0.007 0.056 0.395***

Observations 15,160 24,147 24,142 24,142

All exposures Negative exposures Positive exposures All exposures

Absolute exposure − 0.002

Exposure − 0.006 0.000 0.001

Actual exposure×Pos exposure dummy − 0.005

Positive exposure dummy − 0.021

Observations 24,142 12,846 11,296 24,142

their expected return on a loan.

4.4. Additional robustness tests

4.4.1. Addressing potential endogeneity

4.4.2. Time-varying price of risk

4.4.3. Other currency factors

Competition Lending standards 2SLS

Absolute exposure 0.214*** 0.001 0.227*** − 0.002

Observations 22,758 22,758 24,142 24,142 23,985 23,985 23,985

price of exchange rate risk.

4.4.4. Nonlinear effect of exposure

(1) (2) (3) (4) (5) (6)

Absolute exposure 0.066*** 0.047***

Control variables Yes Yes Yes Yes Yes Yes

Observations 32,035 32,035 32,035 27,920 27,920 27,920

Panel B: Expected default loss premium

(1) (2) (3) (4) (5) (6)

Absolute exposure 0.493*** 1.007***

(1) (2) (3) (4) (5) (6)

Observations 24,142 24,142 24,142 23,436 23,436 23,436

Panel C: Expected return premium

(1) (2) (3) (4) (5) (6)

Absolute exposure 0.058** 0.019

Observations 24,142 24,142 24,142 23,436 23,436 23,436

5. Does exposure affect nonprice loan terms?

6. Summary and conclusions

(1) (2) (3) (4) (5)

Prob(Secured Ln(Loan Syndicate Foreign Prob(Foreign majority lender share

Absolute exposure 0.078*** − 0.014*** 66.597 − 0.740* − 0.182***

Marginal effects (probit models) 0.0199 − 0.0523

Panel B: Monitoring and Covenant Intensity

Absolute exposure 0.048* 0.053* 0.023* 0.025* − 0.021* 0.036*

Exposure − 0.234* 0.207* − 0.238***

Absolute exposure 0.146* − 0.007 0.056 0.395*

Absolute exposure 0.214* 0.001 0.227* − 0.002

Absolute exposure 0.066* 0.047*

Absolute exposure 0.493* 1.007*

Absolute exposure 0.078* − 0.014* 66.597 − 0.740* − 0.182***

Abs. exposure 0.040 0.035* 0.010 0.023* − 0.010 0.014* 0.009

Absolute exposure 0.070 0.034* 0.972* 0.222* 0.028 0.001

Abs. exposure 0.048* 0.057* 0.021* 0.025*

Abs. exposure 0.564* 0.532* 0.258* 0.225*

Abs. exposure − 0.023* 0.009 − 0.035* − 0.001

Abs. exposure 0.014 0.121* − 0.010

Absolute exposure 0.036* 0.018* 0.023* 0.035* 0.020***

Absolute exposure 0.363* 0.145* 0.223* 0.355* 0.141***

Ln(Abs. exposure) 0.018* 0.166* 0.002