Derivative instruments acquired to hedge exposure may be cla

Derivative instruments acquired to hedge exposure may be classified as either a fair value hedge or a cash flow hedge. Distinguish between the two types of hedges.

Solution

A Cash flow hedge is a hedge of exposure to variability in the cash flows of a specific asset or liability, or of a forecasted transaction, that is attributable to a particular risk. It is possible only to hedge some riskassociated with a portion of asset, liability, or forecasted transaction, as long as the effectiveness of the related hedge can be measured

A fair value hedge is a Hedge of exposure to changes in the. fair value of asset or lability. It is used to reduce fluctuations in earnings. caused by changes in fair value