Question

Difference between cash flow hedge and fair value hedge with example

Answer 1

A Cash Flow Hedge is used when there is a need to reduce and manage the particular risk which arises from changes in the cash flows of a financial asset i.e. interest rate risk on a floating rate debt instrument.

Fair value hedge is a hedge of the exposure to changes in fair value of an asset that attributes to a particular risk and could have an impact on the profit or loss. Example can be when the price of a stock or a warehouse full of toys goes down, the fair value hedge goes up and cancels out the losses for whoever did the hedge.