Hedging
Short definition
Hedging is the deliberate reduction of an open market or cash risk with a derivative or a contract. The aim is not speculative profit; it is a narrower band for cash and covenants.
Detailed explanation
Tools: forwards, futures, options, swaps, natural matching. Effectiveness is the offset of cash on the hedged item and the instrument; basis, tenor and amount mismatch cut it.
Hedge accounting (IFRS 9) can damp P&L volatility; an economic hedge need not be an accounting hedge. Policy writes what is hedged, the ratio, tenor, authority and a ban on speculation.
Why it matters for the CFO
In an FX or rate shock, a hedge makes CFADS and inventory cost more predictable. A wrong hedge amplifies the shock from the other side.
How to read it
The hedge ratio between 0 and 100 follows risk appetite; a “full hedge” does not kill basis and cash timing. Mark-to-market margin calls turn a hedge into liquidity risk.
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Definitions are educational. They are not investment, credit or tax advice.