It also argues that IM should not be based on the exposure of the initial position over the entire liquidation horizon, but on the exposure over the initial period required to set up the hedge, plus the exposure to the
hedged position over the remainder of the liquidation horizon.
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.
There will also be a requirement to sleeve a forward
hedged position to the new agreement.
