Hedge Effectiveness
Accounting standards boards around the world have instituted accounting standards that require corporations to measure, using a consistent methodology over the lifecycle of a hedge, how effective their hedges have been and how effective they are likely to be. The US, International and Canadian Accounting Standards Boards have articulated similar requirements for measuring hedge effectiveness: FAS 133 (US), IAS 39 (International), & CICA 3865 (Canada).
The Perfect Hedge is a web-based system designed to provide the necessary calculations:- Derivatives and debt instruments mark-to-market supported with historical market data
- Hedge definition and management
- Prospective and retrospective hedge effectiveness tests. Hedge types supported:
- Interest rate fair value hedges where the total risk is hedged
- Interest rate cashflow hedges including a specialized report for variable rate debt
- Swapped to fix
- FX fair value hedges
- FX cashflow hedges
- Generation of accounting entries for hedges
Hedge Effectiveness Testing Methods
The following Hedge Effectiveness Testing Methods are supported in The Perfect Hedge:
VaR Reduction Analysis
The VaR reduction analysis method is performed by calculating the VaR of underlying positions and the VaR of the derivative positions used to hedge. If the VaR is reduced sufficiently the hedge can be expected to perform effectively.
Regression Analysis
The regression analysis method is a preferred method for certain types of cashflow hedges. The system calculates correlation results by regressing two sets of variable rate fixings (for example LIBOR versus a non-benchmark rate).
Historical Scenario Dollar Offset Analysis
The historical scenario dollar offset analysis method is a powerful hedge effectiveness testing tool where the system generates a set of scenarios based on historical price and rate changes where such changes are calculated automatically from the market data stored on the system. For each scenario, the dollar offset changes in the underlying trades are compared with the dollar offset changes in the derivatives. Then the system calculates a correlation result from the set of dollar offset changes as a measure of hedge effectiveness.
