Question

Briefly explain, in your own words, three of the hedge transaction types. Describe in which situations each would be used and why.

Answer 1

Types of Hedging:

There are three types of Hedging

1. Fair Value Hedging

2. Cashflows Hedging

3. Hedges in Net Investment in a Foreign Operation

1. Fair Value Hedging

Fair Value Hedging refers to hedging the risk for changes in the fair value of Assets and Liabilities.

A situation where Fair Value Hedging is used are

a. Risk of change in Interest Rate of Fixed Rate Loans

b. Risk of change in Foreign Exchange Rates

c. Risk of changes in the value of Equity’s and Commodities

2. Cash Flow Hedging:

The risk being hedged in a cash flow hedge is the exposure to variability in cash flows that is attributable to a particular risk and could affect the income statement.

Situation, where Cash Flow Hedging is used, are

a. Risk of change in Foreign Exchange Rates

b. Risk of changes in Interest Rate of Foreign Country Loans

3. Hedges in Net Investment in a Foreign Operation

The currency risk associated with the translation of the net assets of these foreign operations into the group’s currency.

The situation where Hedges in Net Investment in a Foreign Operation is

a. Investing in Foreign Associates and Subsidiaries