An Empirical Examination of the Correlation between Derivatives Usage and Key Financial Indicators in Botswana

Abstract

The study evaluated derivative usage of 21 firms listed on the Botswana Stock Exchange (BSE) in relation to five key financial indicators that included financial gearing, solvency, liquidity, profitability, and firm size. A logit regression model was run on the data covering year 2019 to the year 2021. The logit model revealed at 99% level of confidence that, a firm’s derivative usage is significantly and positively related to its financial gearing as measured by non-current liabilities to total equity (D/E) ratio. The study also revealed that usage of derivatives by firms listed on the Botswana Stock Exchange (BSE) had no significant relationship with solvency ratio (as measured by total liabilities to total assets ratio), firm size (as measured by total assets) and liquidity ratio (as measured by cash and cash equivalents to total assets). However, the research observed a significant and negative association between derivative usage and profitability ratio (as measured by Profit Before Interest and Taxation (PBIT) to Average total assets ratio). It was further noted that listed firms in Botswana are only using employee options, collateral based swaps, interest rate swaps, and foreign exchange swaps to hedge risks. Hence the study recommends policy makers to institutionalize derivative markets that offer a variety of products that include futures derivative contracts which are currently not in use in the market. The establishment of derivative market in Botswana will reduce an over-reliance on financial borrowing from the banking sector and government agencies by local investors, domestic firms, and multinational firms in Botswana. The use of derivatives also reduces the weighted average cost of capital and hence increases firm’s market value.

Keywords: Derivative usage, key financial indicators, logit regression model, futures contracts

DOI: 10.7176/RJFA/14-20-08

Publication date: December 31^st 2023