Fair value hedges
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Fair value hedges
During foreign exchange trade, there are very high possibilities that a number of risks and insecurities might be noted or occur. These risks might have great impacts on the debt securities as well as on the equity securities which are commonly traded. In order to ensure that these risks are kept at bay or controlled, there have been the adoption and employment of hedges which ensure that such risks do not occur. The commonly used hedges are the fair value and cash flow hedges. This paper hence comes up with a concise description which analyses in details some of the practical implications of fair value hedges on available-for-sale debt securities.
Hedges have been used during trading operations as a way of eliminating any kind of risks that might take place during exchange. A good example is the Foreign Exchange Hedge, also known as FOREX hedge. This kind of a hedge would be used as precise method, which is used by a number of companies towards the elimination of hedge-out on any kind of risk that may come in from the transactions being carried on the foreign exchange currencies. This would be something that is done by the use of Cash Flows or even with Fair Value technique or method. However, it should be noted that all the accounting procedures and behind the methods would always be addressed or checked by the IFRS, the International Financial Reporting Standards (Ryan 45). Our interest is on the Fair Value Hedges: this paper would hence look and discuss the practical implications of fair value hedges on available-for-sale debt securities.
Practical Implications of Fair Value Hedges on Available-for-Sale Debt Securities
As we have seen above, this is a hedge, which ensures there is monitoring of the exposures and some changes, which might occur on the given ‘fair value’ of some well-recognized liability or even asset. They can also be used in monitoring some unrecognized firm. In that case, this kind of a hedge shall be greatly attributable to some particular risks hence effectively bringing about a profit or even a loss on the available-for-sale debt and related securities. It should be noted that this kind of hedge is importantly applied towards eliminating what would be known as ‘fair value’ form of risks on liabilities or assets as they have been reported in the already prepared balance sheet (Weetman 47).
Therefore, it will be necessary that we come to a closer understanding of debt securities. In business and FOREX trade operations, it will be noted that investments would be done in what is known as Debt Securities. In that case, these debt securities will be classified as either: available-for-sale, trading debt securities or even held-to-maturity. On the other hand, it should be understood that investments in the Equity Securities would be given a classification as either trading equity securities or available-for-sale (Weetman 53).
Having understood that, practically, the available-for-sale debt securities would always be reported at the fair value. Because these are short term investments, the application of the fair value hedge would practically control the risks that might come as a result. With the application of the fair value hedges, they will be included to part or component of the accumulated income for the debt securities, and therefore they have to be excluded from being part of the total income. Therefore, the debt securities will hence have to be held until they reach maturity in which they have to continue being recognized or seen at their amortised values (Walter 23).
As well, the fair value hedge has been noted to be very perfect due to its implications practically. For instance, the fair value would change when there is the necessity towards hedging the current cash with the debt securities as a way of solving the risks of cash flow which include things like volatility which results from the rates of interest as well as the price risks of the given commodity or liability. There is another important implication which can be enumerated: the application of this hedge makes it possible to classify a complex instrument which would be able to measure that exact fair value for a given derivative with the available for-sale debt securities (Eiteman 62). This is a kind of classification that can effectively occur within the initial recognition when the security is almost ready for sale. Therefore, any given financial liability or even asset can be easily designated so long as there has been the effective application and measurement of its fair value.
As well, since it is very true that this kind of an hedge will require that there is the exact fair value measured for all the hedging items, it use as an option shall be an effective instrument which brings about beneficial accounting during the selling process. For instance, let us say that someone intends to make a hedge of a given item, which would involve the use of a derivative of the fair value hedge option. The individual will thus be able to achieve a similar reporting result, which will be the fair value hedge, and this will be achieved without looking at the work that is ongoing towards maintaining the eligibility for the given accounting hedge. However, it should be noted that there would be a number of restrictions on this kind of ability towards designating a given non-derivative tool or instrument to be a hedging item (Ryan 62).
Another importance with the fair value hedges is that they would effectively avail the procedures since they would be used on the Available-for-sale debt securities. The importance for this kind of practical application is that they can effectively forecast the future interests on the receipts and on the debt instruments which might be resulting from these securities. This means that any kind of insecurities and risks that might have occurred during the transaction would never take place (Eiteman 79). This places the trader on the safer side and hence ensuring that he or she does not end up in a loosing business. Since the available-for-sale debt securities can not in any way be held to maturity, it means that they can be traded at any given time. However, changes would always take place during the FOREX trade operations and hence there would be a possibility of incurring a number of risks during the trading operations. Due to that fact, the use of these fair value hedges provides the necessary equipment in ensuring that all the possible risks are never realized. This is what makes the use of hedges in this kind of trade to be something very important (Zhao 77).
Since we have noted that there are very many practical implications of the fair value hedges on available-for-sale debt securities, it would be necessary that they are competently applied in accounting and as financial instruments which would be effective in regulating and determining the financial statements towards estimations (Zhao 84). This would hence ensure that there is no misconception which might result in increased negativities within the trading operations. This is to say that these FOREX Hedges would be very useful in ensuring that all the commonplace risks which would occur in security trading are solved and dealt with before they can cause adverse effects on the trade operations.
Eiteman, K. Multinational business finance. Oxford: Oxford University Press, 2007.
Ryan, Stephen G. Financial instruments and institutions: accounting and disclosure. Cambridge: Cambridge University Press, 2007.
Walter, Antoniotti. Financial Accounting. Oxford: Oxford University Press, 2005.
Weetman, Pauline. Financial Accounting: an introduction. New Jersey: Prentice Hall, 2006.
Zhao, Jin. Commodity and Financial futures as hedges against inflation. Hong Kong: Oxford University Press, 1988.