What is the exact difference between a cash flow hedge and a fair value hedge? in bpp book, in an example a future contract for hedging purchase of certain item of inventory was taken as fair value hedge.isn’t it that raw material etc hedges are considered to be cash flow hedge instead of fair value?
i dont think it states it in particular in IAS39 but it makes sense as raw materials are affecting the cash flow – i know there is an instant pair/ match off in FV hedge (loss on risk is matched with gain on the derivative) and this is not the case in cash flow hedge as there is no match in the current period. CF Hedge covers the risk of changes in cash flow while FV Hedge covers the risk in changes in asset/liab – i saw this question Artwright from Dec-04 that covers this topic
hmmm….alright thanks.but i still think there may be something else too.anyway its useless worrying about it now.
There are 3 types of hedge items..
1) Recognised assets, Liabilities
2) Firm commitment
3) Forecast transaction
Fair value hedge is appied to the exposure of change in fair value of recognised asset/liability or Firm commitment
And cash flow hedge is applied to variability in cash flow of a recognised asset/liability or highly probable forecast transaction..!!
And as an exception hedge of a foreign currency risk of firm commitment may be accounted for as a cash flow hedge or a fair value hedge
In your example there is firm commitment and as there is no exposure to variability in cash flow as the contract has been finalised there is just a risk of change in fair value of the hedge item(material) thats why it is a fair value hedge
A useful way to remember its logic is a rule of thumb which i found after lots of research
If asset/liability is not being settled but still cash flows are being changed (Like variable rate borrowing) then it is a cash flow hedge
If asset/liability is not being settled and cash flows are also not being changed (Like fixed rate borrowing) then it is a fair value hedge
You must be logged in to reply to this topic.