Question

In your discussion you need to answer FOUR of the hedge issues below:
 Why companies do hedging?
 How to determine which types of hedging companies should undertake?
 What are the required hedging arrangement companies need to prepare to fulfil hedge
accounting requirement?
 Are all types of hedging activities qualified to be reported under hedge accounting?
 What is the impact on the presentation of companies’ performance when hedge
accounting is applied?
 Explain the economic information reported by accounting for cash flow hedge, fair value
hedge and net investment hedge

Answer 1

1. Why companies do hedging ?

Answer= Companies do not like risk, and they do not consider it desirable. Companies will undertake risk only when they are adequately compensated for it. By reducing risk , they can avoid cash flow fluctuations and thus, increase value of their investment. Companies always tries to find ways to reduce risk and hedging is used for reducing risk.

By hedging, the managers can focus on operations and other important matters directly affecting the business rather than worrying on external factors like fluctuation in exchange rate over which the manager has no control.

2. How to determine which types of hedging companies should undertake ?

Answer= Types of hedging will depend on   the type of company’s business.

For a company dealing in currency , a foreign currency option is a handy method of reducing foreign exchange risk.

For a company dealing in commodity, options on commodities are very popular.

For example, an oil company importing oil in bulk quantities, expecting an increase in prices of oil, can lock the price of oil by purchasing an option to buy oil at a predetermined future date at a specified exercise price.

Hedging through forward contract- Forward contract is similar to an option in hedging risk, but the striking difference is that both the seller and buyer are bound by the contract.

3. What are the required hedging arrangement companies need to prepare to fulfil hedge accounting requirement ?

Ans= Under US GAAP, hedge accounting allows an entity to selectively measure assets, liabilities and firm’s commitments on a basis different from that otherwise stipulated or to defer the recognition in profit and loss of loss or gains on derivatives.
Under US GAAP, hedge accounting is voluntary, but is allowed only when proper documentation are maintained like type of hedging relationship, nature of risk being hedged, identification of hedging instrument, etc.

4. What is the impact on the presentation of companies performance when hedge accounting is applied ?