What is the primary difference between a cash flow hedge and a fair value hedge?
Lesson Summary
| Item | Fair Value Hedge | Cash Flow Hedge |
|---|---|---|
| Gains/losses for what is being hedged | Go straight to balance sheet and P&L | Cash inflows and outflows are actual values on P&L |
| Gains/losses for hedging instrument | Go straight to balance sheet and P&L | Effective portion to OCI/ Ineffective portion to P&L |
What do fair value and cash flow hedges mean?
In summary, a fair value hedge is used to mitigate risk created by fixed exposures such as fixed costs, prices, rates, or terms. Whereas a cash flow hedge is used to mitigate risk from variable exposures.
What is the difference between hedging and hedge accounting?
Hedging is an economic concept designed to reduce risk. Hedge accounting is designed to ensure economic results are reflected in the accounts, when normal accounting rules would not give that result.
How does fair value hedge work?
Fair value hedge is a hedge of the exposure to changes in fair value of a recognized asset or liability or unrecognized firm commitment, or a component of any such item, that is attributable to a particular risk and could affect profit or loss.
What is the purpose of a fair value hedge?
A Fair Value Hedge is used when an entity is looking to eliminate or reduce the exposure that arises from changes in the fair value of a financial asset or liability (or other eligible exposure) due to changes in a particular risk, such as interest rate risk on a fixed rate debt instrument.
What is a cash flow hedge example?
Cash Flow Hedge Example You want to know how much you will pay in the future, as you need to make some budget, etc. Therefore you enter into interest rate swap to receive LIBOR 12 M + 0.5% / pay 2% fixed. This is cash flow hedge – you fixed your cash flows and you will always pay 2%.
What is fair value principle in accounting?
Fair value accounting refers to the practice of measuring your business’s liabilities and assets at their current market value. In other words, “fair value” is the amount that an asset could be sold for (or that a liability could be settled for) that’s fair to both buyer and seller.
What FAS 113?
Financial Accounting Statement (FAS) 113,1. “Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts” provides guidance on how to account for reinsurance transactions that meet certain risk transfer require- ments. It was effective for fiscal years beginning after Dec. 15, 1992.
What FAS 52?
ASC 830 (aka FAS 52) provides the accounting and reporting requirements for foreign currency transactions and the translation of financial statements from a foreign currency to the reporting currency.
When should a cash flow hedge be terminated?
Cash flow hedge accounting is required to be discontinued when the variability in cash flows of the hedged forecasted transaction cease, for example, when a forecasted transaction becomes a firm commitment.
Do the best hedge funds hedge?
We provide a simple argument that suggests that better-informed hedge funds choose to have less exposure to factor risk. Consistent with this argument, we find that hedge funds that exhibit lower R -squareds with respect to systematic factors have higher Sharpe ratios, higher information ratios, and higher alphas.
What is a cash flow hedge?
In short – A cash flow hedge is a hedge of the exposure to variability in cash flows that is attributable to a particular risk associated with all, or a component of, a recognized asset or liability or a highly probable forecast transaction, and could affect profit or loss.
What is hedge and hedging strategies?
Taking an Opposite Position. This is one of the easiest hedging strategies you can apply.
What are the disadvantages of hedge funds?
Higher Fee Structure