Question

How does the financial statement impact differ between the cash flow hedges and the fair value hedges of the AFS security portfolio?

Answer 1

Hedge is an instrument to mititage risk. On one side where Cash Flow Hedge(CFH) mitigate the risk of extra payment that you expect, whereas Fair Value Hedge(FVH) mitigate the risk of fall in fair value of Assets of Liability.

Differences are:

1. In FVH,the hedged instrument is the Asset or Liability whose fair value is to be shielded, and the Hedging Instrument may be a Derivatives Contract. In CFH, hedged instrument is the Cash Flow relating to a Contract or Agreement(say Sales Contract), and the Hedgin Instrument may be a Derivatives Contract.

2. In FVH, the hedging instruments value are affected and entry is direcly passed through Statement of Profit and Loss, whereas in CFH, a new Asset or Liability is recognised as Derivative(Asset or Liability) and entry is passed through Other Comprehensive Income(OCI).

In case of AFS Security Portfolio, the same rationale would apply. Fair Value Hedge would mitigate the risk of changes in Fair Value of AFS Security whereas Cash Flow Hedge would mitigate the Cash Flow variation risks relating to AFS Security.