I think that i am confused about this. can someone tell me if i have this right
All hedges are carried on the b/s at FV
Of the three types of hedges only Fair Value hedges are imediatly reported to i/s
Here is where things are foggy.
with all three types, the ineffective portion is taken to i/s during the period. Is that right? that would mean that the hedges get further subdivided into effective and ineffective. Then all g/l for fair vaue hedges go to i/s but for the other two only the ineffective portion goes to i/s while the rest goes to OCI. Does that sound right?
And finaly the accumulated effective portion of the cash flow hedge that sits in OCI is taken to the i/s when?
Yes, in all three types, any portion that is not effective is recognized in the income statement (I/S). For Fair Value Hedge both the realized and unrealized G/L goes to the I/S. Plus any ineffective portion goes to I/S too b/c “the firm” “you” elected to take all the risks allowing it to float at Fair Value.
In the Cash Flow hedge, your position is that you are hedging some CF in the future so you don’t want all that volatility to swing up and down in your I/S while you wait for the $ to hit the bank, so you stash it in the B/S under the OCI line and only recognize G/L when the transaction takes place in the I/S.
The intuition is the same for the Foreign Sub Hedge, you are trying to reduce volatility from foreign x-change rates fluctuations from subs that are using the current rate method, which means they don’t operate in your “parent” currency so you have no use for their currency until you convert year end, you don’t function in the sub currency (buy/sell). You stash your hedge value where you got the FX exposure, in the OCI account where you made the CTA account (remember from FRA-current rate method). You are trying to neutralize that CTA account. If your foreign sub used your currency as the functional currency you would be using the Temporal Method and wouldn’t have a CTA account in the OCI section on the B/S, exchange G/L it would be in your I/S already. Guess u wouldn’t need to hedge your own currency fr the sub at that point.
Credit to John Harris b/c the book does a bad job. I hope that makes sense, at least the logic behind it so you can remember it.
Thanks very much for that – the CFA and schweser books had pretty crappy explanations!