Capital Markets Examiner School, Providence, RI

Fair Value vs. Cash Flow

Fair value hedge is a hedge of the exposure to changes in fair value of a recognized asset or liability or unrecognized firm commitment, or a component of any such item, that is attributable to a particular risk and could affect the margin. Cash flow hedge is a hedge of the exposure to variability in cash flows that is attributable to a particular risk associated with all or a component of a recognized asset or liability or a highly probable forecast transaction, and could affect the margin.

Fair Value vs. Cash Flow

The key to differentiate is WHAT RISK you hedge . Always ask yourself, why you undertake the hedging instrument.

Key Differences The main difference between a cash flow and a fixed-value hedge is that only one is linked to an asset or liability that provides regular payments to the holder -- the cash flow hedge. While both are used to hedge against changes in the value of the asset, the cash flow hedge is more often tied to changes in one or more types of interest rates.