What is a cash flow hedge and how does it differ from a fair value hedge?
A core Corporate Treasury interview question — asked in analyst and associate interviews across IB, PE, and the Big 4.
THE SHORT ANSWER
A cash flow hedge hedges exposure to variability in future cash flows, such as variable-rate debt or forecasted FX transactions. Changes in the hedging instrument's fair value are recorded in OCI and reclassified to profit or loss when the hedged item affects earnings. A fair value hedge hedges changes in the fair value of a recognized asset or liability, like fixed-rate debt. Here, both the hedging instrument and hedged item are adjusted through profit or loss. The key difference is where gains/losses are recognized: OCI vs. P&L.
WHAT INTERVIEWERS LISTEN FOR
- ✓Cash flow hedge: OCI, then reclassified to P&L
- ✓Fair value hedge: P&L immediately
- ✓Distinguishes between variability vs. fair value risk
COMMON MISTAKES
- ✗Confuses which goes to OCI
- ✗Thinks both are same
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