The effectiveness of a hedge from an economic perspective depends on the amount of risk reduction obtained through the off-setting hedged position
. Since the cash flows of the hedge position rarely completely off-set the cash flows of the hedged item due to the basis risk, the optimal off-setting position may be more or less than the hedged item.
Smithfield also indicated that it does not expect its fourth quarter Hog Production segment results to reflect the benefits of the recently and dramatically improved live hog production environment because of significant mark-to-market losses on a portion of its lean hog hedged position
. The spokesman added: "Smithfield noted that these losses are the result of the sizeable and unexpected run-up in the futures curve for lean hogs for the summer and fall months of 2010.
"With our balanced portfolio of assets and hedged position
, we are positioned to build liquidity and strengthen our balance sheet during this low commodity price environment and we will continue to monitor our discretionary drilling capital on an ongoing basis."
The German bank cited recent progress in the company's strategy to address four key business issues, recent share price weakness and the company's well hedged position
to fuel price rises, as the reasons behind its decision.
The advantage of hedging with a currency pair transaction includes maturity date flexibility (the hedged position
has no defined maturity date) and specific size determination (any size transaction can be hedged).
This type of accounting is required when a hedged position
is not measured at fair value with recognition of gains/losses in income in accordance with regular GAAP.
Accordingly, firms using the fair value option could mark to market both the credit derivative and the hedged position
and report changes in their fair values in current earnings.
For example, suppose that the change in the value of the hedged position
is always -$0.20.
The taxpayer would then hold the hedged position
until a future tax year, and eventually cover it with the low-basis long position.
From experience, an unhedged future cash flow is just as risky as a 100% hedged position
unless the business is 100% certain that it will realize a cash flow.