What is a fair value hedge?
The risk being hedged in a fair value hedge is a change in the fair value of an asset or liability or an unrecognised firm commitment that is attributable to a particular risk and could affect P&L. Changes in fair value might arise through changes in interest rates (for fixed-rate loans), foreign exchange rates, equity prices or commodity prices.
Should credit risk be considered in a fair value hedge?
Under U.S. accounting standards, the credit risk of either the organization (when a liability) or the counterparty (when an asset) is required to be considered in the valuation of the derivative hedging instrument in a Fair Value Hedge when applying quantitative methods of hedge effectiveness testing.
What is hedge effectiveness?
Hedge effectiveness is the extent to which changes in the fair value or cash flows of the hedging instrument offset the changes in the fair value or cash flows of the hedged item.