External commercial borrowings (ECBs) of Indian non-financial firms have grown by 107 % in past few years. Looking at the high reliance of firms on external debt, this paper investigates the effect of foreign exchange, interest rate and firm specific risk on the debt issuance and retirement decision. It also investigates the factors affecting equity issuance and retirement decision of the firms. Foreign exchange risk and interest rate risk is estimated using stochastic volatility and GARCH (1,1) methods. Firm specific risk is calculated using Black-Scholes Merton model for company valuation. The results highlight that interest rate risk negatively affects the debt issuance and positively affects debt retirement decision of the firms. However, the foreign exchange risk does not affect debt issuance and retirement decision. Firm-specific risk negatively affects propensity of debt issuance of firms but plays no role in debt retirement. Foreign exchange risk, firm-specific risk, and profitability negatively affect propensity of issuance of debt to issuance of equity. This result supports the view that risky firms are more likely to finance their capital needs via new equity issues rather than by new debt issues to avoid the high-risk premium and to limit the likelihood of bankruptcy.
Estimates of foreign exchange risk premia: a pricing kernel approach