5.11 CASE STUDY: HEDGING A FORECAST SALE AND SUBSEQUENT RECEIVABLE WITH A KNOCK-IN FORWARD (INSTRUMENT IN ITS ENTIRETY)

In this section I will cover an approach to apply hedge accounting when (i) a knock-in forward is involved and (ii) the entity does not want to split the instrument (see previous section) for hedge accounting purposes due to its operational complexity.

5.11.1 Hedging Relationship Documentation

Under the approach covered in this section the hedging instrument would be the knock-in forward in its entirety. The hedged item was the cash flow stemming from the USD 100 million of a highly expected forecast sale (see previous cases). The risk management objective was to mitigate its variability against movements in the EUR–USD FX rate. ABC documented the hedging relationship as follows:

Hedging relationship documentation
Risk management objective and strategy for undertaking the hedge The objective of the hedge is to protect the EUR value of the cash flow stemming from a USD 100 million highly expected sale of finished goods and its ensuing receivable against unfavourable movements in the EUR–USD exchange rate.This hedging objective is consistent with the entity's overall FX risk management strategy of reducing the variability of its profit or loss statement caused by purchases and sales denominated in foreign currency.The designated risk being hedged is the risk of changes in the EUR fair value of the highly expected cash flow
Type of hedge Cash flow hedge ...

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