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A reporting entity hedging a foreign currency exposure may be able to pursue cash flow or fair value hedging strategies that would not otherwise be permitted for hedges of other risks. These include:
  • applying hedge accounting to intercompany foreign-currency forecasted transactions (intercompany transactions are not otherwise permitted to be hedged, since they generally do not affect consolidated earnings),
  • using intercompany foreign-exchange derivatives as hedging instruments in consolidated financial statements under certain limited circumstances (not permitted for other types of intercompany derivatives, such as interest rate derivatives), and
  • hedging a net investment in a foreign operation.
A net investment hedge allows a reporting entity to hedge its investment in a foreign operation, which is comprised of the assets and liabilities of the foreign operation with dissimilar risks, as a single hedged item. This would not otherwise be permitted under cash flow or fair value hedge accounting guidance. The change in the fair value of the hedging instrument (or in some cases, a portion) designated as a net investment hedge is recognized in cumulative translation adjustment (CTA) within OCI and held there until the hedged net investment is sold or liquidated; at that point, the amount recognized in CTA is reclassified to earnings and reported in the same line item as the gain or loss on the liquidation of the net investment.
Figure DH 5-2 illustrates the overlap between fair value, cash flow, and foreign currency hedges, including a hedge of the net investment in a foreign operation.
Figure DH 5-2
Interaction between fair value, cash flow, and foreign currency hedges
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