Cash Flow Hedges Research Articles

Shedding light on foreign currency cash flow hedges: transparency and the hedging decision

Utilizing firms in the S&P 500, we study whether greater transparency in the reporting of other comprehensive income (OCI) items, as mandated by ASU 2011-05, resulted in a reduction in information asymmetry, a change in the value relevance of this information, or a change in hedging practice. Our results show that while transparent reporting reduced information asymmetry, firms that engage in cash flow hedging do have greater information asymmetry than their counterparts that do not hedge. We find evidence that investors penalize firm value for greater volatility of OCI relative to net income volatility when reported transparently. When permitted, managers were able to mitigate the negative impact by reporting OCI only in the Statement of Shareholders’ Equity. We conclude that managers’ concerns regarding potential confusion surrounding OCI volatility following more prominent reporting led to changes in hedging behavior. After transparent reporting, we find a reduced likelihood of foreign currency cash flow (FXCF) hedges and a reduced level of FXCF hedging among firms experiencing the greatest volatility of unrealized hedging gains and losses.

Asymmetric effects of fair value adjustments on dividend policy

We examine the effect of unrealized fair value adjustments resulting from derivatives classified as cash flow hedges on the dividend policy of UK firms. We theorise and empirically demonstrate that companies differentiate between positive and negative fair value adjustments. When unrealised gains are recorded under ‘Other comprehensive income’ firms do not increase dividend payouts; as such it can be argued that legal requirements surpass potential signaling considerations. However, for unrealized losses, firms reduce their dividend payouts, even when regulatory arrangements do not necessarily mandate this. Furthermore, firms adjust their dividends based on unrealized losses under different levels of firm risk, future growth opportunities and financial distress. Overall, our findings suggest that managers display a conservative behavior aiming to safeguard company assets, by effectively treating unrealized gains as ‘transitory’ and unrealised losses as ‘persistent’.

Supply Chain Finance Redefined: A Supply Chain-Centric Viewpoint of Working Capital, Hedging, and Risk Management

Problem definition: The narrow definition of supply chain finance (SCF) as a financing scheme for accounts receivables fails to capture the knowledge creation of MSOM research scholars of the last 25 years who labored in the area under this label. A redefined definition of the research-and-application field, under the acronym integrated SCF (iSCF), better reflects the interplay of operational, financial, and risk management decisions our scholars and practitioners care about. The foundational knowledge of this field is ready to come into the classroom and elevate SCF courses from the typical “accounting and finance for supply chain managers” content to a supply-chain-centric viewpoint of important decisions in working capital management, effective cash-flow hedging, and integrated risk management of global supply chain risks. We outline the main research themes behind the iSCF research, and teaching, field; highlight concepts ready for the classroom; and pose some open research questions pointing to the future promise of the field. Methodology/results: Forum paper. MSOM Fellow opinion on topic of supply chain finance and risk management based on his published research. Managerial implications: A supply-chain-centric view on state-of-the-art practices for improved working capital, hedging, and risk management in global supply chains (integrated supply chain finance).

TRANSAKSI KEUANGAN DERIVATIF LINDUNG NILAI (HEDGING) PADA PT. ASTRA INTERNATIONAL TBK

Based on research conducted by the Journal of Management and Business, hedging is an action to protect companies from the risk of loss of foreign exchange rates that occur due to business transactions, so that companies can conduct business transactions with a number of foreign currenciesto avoid the risk of foreign exchange losses that occur due to business transactions carried out by companies using derivative instruments (Adrian Sutedi in Desmiza, 2015). With derivative instruments, companies can minimize the possibility of bankruptcy, making it easier for a company to be able to get loans with lower interest rates (because the risk obtained by lenders is lower) (Zahra &; Tjahjono, 2020). As for the purpose of doing this research is to find out how the use of hedging applied by PT. Astra International Tbk uses financial derivative instruments from the 2022 annual financial reports. The method used by researchers in this study is a qualitative method with a content analysis approach.The results of this study researchers found that PT. Astra International Tbk uses several hedging derivative financial transactions, such as cross currency swaps, interest rate swaps, commodity contracts and foreign exchange futures contracts. Of the four types of hedging derivative instruments, PT. Astra International Tbk classifies these instruments into cash flow hedges that comply with the hedge accounting objective criteria and cash flow hedge categories that do not comply with the hedge accounting objective criteria.

Komponen-Komponen Other Comprehensive Income dan Relevansi Risiko Comprehensive Income

This study aims to examine the risk relevance net income, comprehensive income, and component-competent other comprehensive income. Specifically, this study investigates the risk relevance of net income volatility, comprehensive income volatility, and component-component other comprehensive income volatility on stock return volatility. The study population was finance and banking companies listed in Indonesia Stock Exchange period 2013-2017. Samples are selected with purposive sampling method. This study employed a quantitative method with simple linear regression because for variable tested had a number of different samples. The result of this research showed the risk relevance net income and comprehensive income can not be proven statistically. But of the five component of OCI only volatility change in the fair value of a financial instrument in a cash flow hedge are shown to have a significant positive effect on volatility stock return.

Reconsidering the Prudential Filter for the Cash Flow Hedge Reserve in View of the Purpose of Banking Regulation

Common Equity Tier 1 capital of credit institutions is adjusted by the prudential filter for the cash flow hedge reserve according to art. 33(1)(a) CRR. Thereby, fair value changes of hedging instruments, especially of derivatives, are neutralized by imputed fair value changes of future cash flows that are part of a cash flow hedge. However, these future cash flows are (mostly) expected to occur under market conditions and, thus, imputed fair value changes are not reflected in changes of present values derived from real transactions that exist at the time of the regulatory capital calculation. As a result, positive effects on Common Equity Tier 1 capital can be viewed critically in regard to the prudence principle of banking supervision if an initial reduction in Common Equity Tier 1 capital due to losses from hedging instruments is corrected. Furthermore, the adjustment is case specific and depends on the hedge effectiveness, which is questionable because of consistency reasons. To solve these weaknesses, we suggest to eliminate the prudential filter for the cash flow hedge reserve as a whole. This would lead to a better quality of Common Equity Tier 1 capital by improving its loss absorbency and as a side effect to a reduction in complexity enhancing supervision through regulatory authorities and market discipline. Furthermore, we demonstrate the impact that the proposed abolishment of the prudential filter for the cash flow hedge reserve would have on the Common Equity Tier 1 capital ratios of the largest European banks in 2014–2019

Хеджування грошових потоків із використанням процентних свопів: облік за МСФЗ

The paper discloses the accounting treatment for cash flow hedge of exposure to risks arising from the changes in cash flows of financial instruments, in which interest rate swaps are used as hedging instruments. The author considers the economic meaning of hedge relationship as an instrument of reducing financial risks being inherent to financial assets and financial liabilities of the bank. The paper represents the purpose of the cash flow hedge as well as the mechanics of the interest rate swap as the most efficient instrument of the cash flow hedge relationship. The author analyzes the statements of IFRS 9 on the cash flow hedge accounting: recognizing the cash flow hedge reserve, assessing the portion of gain or loss on the swap that is either effective or ineffective hedge. The paper explains the procedures of the cash flow hedge accounting to reduce interest rate risks that arises from the changes in the cash flows of floating-rate financial liabilities. In particular, the paper covers the procedures of the fair value measurement of a hedging instrument as the present value of the difference between cash inflows and outflows discounted at spot rates for each period. The author discloses the accounting for the cash flow hedge: the accrual of interests on the financial liability, the change in the fair value of swap, the net settlement of the interest on swap, the reclassification of the interest on swap and settlement of interests on the financial liability. The article suggests the accounting procedures comply with the requirements of IFRS 9 on the cash flow hedge accounting and recommends the implementation to Ukrainian banks.

The Effect of Mandatory Disclosure on Market Inefficiencies: Evidence from FASB Statement No. 161

ABSTRACTPrior research finds that unrealized gains/losses on cash flow hedges are negatively associated with future earnings, and that investors and analysts fail to anticipate this association. These studies speculate that this mispricing is due to either poor derivatives disclosures or the accounting model for cash flow hedges. We examine whether enhanced mandatory derivatives disclosures set forth in FAS 161 improve users' understanding of firms' hedging activities and offer three main findings. First, we find that this mispricing does not persist after FAS 161. Second, we find that the correction of mispricing is greatest when disclosure might help investors most. Finally, we find that analyst forecast accuracy improves after FAS 161. Overall, our results suggest that the enhanced mandatory derivative disclosures required by FAS 161 improved users' understanding of the effects of derivative and hedging activities on future firm performance and firm value—and consequently mitigated investor mispricing.

The Usefulness of Other Comprehensive Income for Predicting Future Earnings

This study investigates whether other comprehensive income (OCI) reported in the statement of comprehensive income (one of the main financial statements after the adoption of K-IFRS) predicts a firm’s future performance. Using the quarterly data of Korean listed companies, we examine the association between OCI estimates and future earnings. First of all, we find that OCI is positively associated with earnings in both 1- and 2-quarter ahead, supporting the predictive value of OCI. When we break down OCI into its individual components, our results suggest that the net unrealized gains/losses on available-for-sale (AFS) investment securities are positively associated with future earnings, while the other components (e.g., net unrealized gains/losses on valuation of cash flow hedge derivatives) present insignificant results. In addition, we investigate whether the reliability in OCI estimates enhances the predictive value of OCI to predict future performance. We find that the predictive ability of OCI, in particular the net unrealized gains/losses on available-for-sale (AFS) investment securities, becomes more pronounced when firms are audited by the Big 4 audit firms. Overall, our study suggests that information content embedded in OCI can provide decision-useful information that is helpful for the prediction of future firm performance.

Hedging Longevity Risk: Does the Structure of the Financial Instrument Matter?

Longevity-linked securities can be constructed either as cash flow hedging instruments or as value hedging instruments. This article studies the interaction between the structure of longevity-linked securities and shareholder value. Relying on a strand of literature that investigates corporate risk management decisions made in the interests of shareholders, we present a framework that compares cash flow hedges with value hedges. Both our theoretical model and numerical experiments show that value hedging dominates cash flow hedging in the context of management decisions being made to maximize shareholder value. This finding provides an explanation for the failure of some attempted issues of longevity risk transfer instruments and suggests efficient alternate structures.

Hedge accounting and investors’ view of FX risk

Purpose This paper aims to examine the foreign exchange (FX) risk effects of cash flow hedge accounting (HA). To the extent the HA qualification criteria and detailed documentation give investors confidence that FX derivatives effectively hedge risk, market-assigned FX risk premiums will be lower for firms using cash flow HA. Design/methodology/approach Probit analyses rely on the HA designation to examine the decision to use cash flow HA. Primary analyses test the hypothesized relationship between the magnitude of FX risk premiums and such HA use. Additional analyses allow for the interaction between cash flow HA use and the extent of FX derivatives use. Findings Hypothesis tests indicate that the magnitude of the FX risk premium is, on average, lower for firms designated as effective cash flow hedgers. In additional tests, the evidence suggests that the market assigns a lower FX risk premium to firms using a higher level of FX derivatives as effective cash flow hedges. Practical implications The findings suggest that cash flow HA provides risk-relevant information to investors. Such positive effects of HA on investors’ understanding of risk management may guide US accounting regulators in their efforts to improve HA. Corporate treasurers also may benefit from these insights into evaluating the use of HA. Originality/value Responding to the call for research on the risk relevance of cash flow HA, this paper merges the HA literature with the FX risk management literature to directly examine the relationship between HA use and FX risk premiums for manufacturing firms. The authors take an innovative approach using FX rates to which each firm is most exposed and provide evidence consistent with the argument that this approach is helpful in understanding both the decision to use cash flow HA and the effect of such HA use on market-assigned FX risk premiums.

The Effect of Applying Hedge Accounting in Reducing Future Financial Risks in Jordanian Commercial Banks

The Effect of Applying Hedge Accounting in Reducing Future Financial Risks in Jordanian Commercial Banks
 
 The study aimed to identify the effect of applying hedge accounting on reducing the future financial risks of the Jordanian commercial banks by using financial ratios to find a practical method of calculating the hedge with its three categories and to address the future financial risks of commercial banks in Jordan.
 
 The researchers used both the descriptive and analytical methods based on the financial statements and reports of the Jordanian commercial banks for the period (2012-2017), in addition of using financial indicators. The study community included the published financial statements of the Jordanian commercial banks before applying hedge accounting and after in accordance with the amendments to IFRS Standard No. 9, as well as the banks listed in the Amman Exchange Market for the period of study. The sample of the study included all Jordanian commercial banks that disclosed the application of hedge accounting in their annual financial statements.
 
 The study concluded that there is a strong correlation between cash flow hedges and reducing the financial risks of Jordanian commercial banks after the application of hedge accounting for the period (2012-2017), and that there is a strong correlation between fair value hedges and reducing the financial risks.
 
 The fair value hedges have an explanatory capacity to reduce the financial risk by 27.4%. This has been derived from the R2 value. There is a weak correlation between the net investments in foreign currencies and the financial risks. The study recommended the importance of maintaining the use of hedge accounting to achieve fairness and honest representation in the final financial statements to the benefit of internal and external users.

PENYAJIAN PENDAPATAN KOMPREHENSIF LAIN: INVESTIGASI PADA INDUSTRI INFRASTRUKTUR DAN UTILITAS

The purpose of this study was to investigate how the implementation of the presentation of other comprehensive income (OCI) after IFRS implementation in the industrial sector of infrastructure and utility that is listed in the Indonesia Stock Exchange in 2012-2015. The samples were processed as many as 48 companies. OCI component is observed on foreign exchange IAS 10, IAS 24, employee benefits, IAS 55 available for sale and cash flow hedges, IAS 16/19 revaluation of tangible and intangible, and SFAS 15 associations and venture. These research data analysis methods were using cross tabulation and analysis done by testing different test Cramer's V because the data being tested were nominal and non-parametric. Results of the study were that the foreign exchange component of OCI, employment benefits and securities available for sale were the components most often served. As for the foreign exchange component was found a difference in the presentation. Research on the future OCI can be done by digging a further impact on the condition value of OCI micro and macro enterprises.Keywords: Other Comprehensive Income, Foreign Exchange, Employee Benefits, Securities Available for Sale and Hedging, Revaluation of Tangible and Intangible, and Association

Hedge Accounting and Market Value of Quoted Manufacturing Firms in Nigeria: Panel Data Evidence

In a developing economy such as Nigeria, the business environment is characterized with risk that affects the operational efficiency and the performance of quoted firms. There is needed to make policies that will hedge against risk in the operating environment. This study examined the effect of hedge accounting on the market value of quoted oil and gas firms. A sample of 10 oil and gas firms was selected based on data quality and availability to address the requirements of the variables in the regression model. The study modeled market value as linear function of cash flow hedging, investment hedging and fair value hedging. Cross sectional data was sources from financial statement of the selected firms from 2011 to 2016. From the panel data result, (Fixed Effect Model) the study found that cash flow hedging have positive and significant relationship with market value while fair value hedging and investment hedging have positive but not significant relationship with market value of the quoted oil and gas firms. We therefore recommend that hedge accounting policies should be properly integrated to the operational objectives of the firms.

CRISE FISCAL DOS ESTADOS E O CASO DO RIO DE JANEIRO / STATE FISCAL CRISES, AND THE CASE OF RIO DE JANEIRO

doi: 10.12957/geouerj.2017.32070 This article analyzes public accounts of Brazilian states, focusing on Rio de Janeiro. We examined the public debt and the key indicators for public account dynamics: staff costs, accounts payable, and investments. The first conclusion is that few states have a debt problem. The second conclusion is that the fiscal crisis is structural, notwithstanding the fall in revenues due to the economic recession. It is related to the high budget staff cost fixed share, especially due to social security imbalance. Thus, moments of fall in revenues result in high deficits. In addition to that, budget rigidity has resulted in great liquidity problems, which are expressed by the excessive use of accounts payable without equivalent cash flow hedge. Consequently, we also concluded that commitment to the fiscal recovery program proposed by the Federal Government seems inevitable to the states of Rio de Janeiro, Rio Grande do Sul and Minas Gerais. The agreement requirements, however, are not enough to prevent new renegotiation of state debts in a few years.

Managing earnings risk under SFAS 133/IAS 39: the case of cash flow hedges

Whereas empirical studies suggest that firm hedging is influenced by accounting standards such as SFAS 133 and IAS 39, the nature of earnings risk management remains a puzzle. I develop a model that shows how non-financial firms that prefer predictable earnings jointly optimize their hedging strategy and the choice between fair-value and hedge accounting. I also examine the implications of these decisions for earnings predictability under SFAS 133/IAS 39. In this model, which has two accounting periods, earnings uncertainty arises from economic shocks and accounting mismatches. The specific influence of accounting mismatches is isolated with two benchmarks, one for firm hedging (cash flow hedging) and another for an accounting system that fully complies with the matching principle. In this forward-looking analysis, most firms significantly decrease the hedging of long-term earnings when faced with persistent price dynamics. Under non-persistent price dynamics, the levels of long-term earnings hedging are only slightly reduced. Therefore, the influence of accounting mismatches on firm hedging is highly dependent on the economic environment in which a firm operates, which suggests that the potential influence of accounting on firm hedging may be difficult to identify in archival studies. The analysis also offers a forward-looking perspective on the changing properties of earnings since the late 1970s that supplements the existing body of archival accounting studies. For example, under persistent price dynamics, forward-looking short-term earnings volatility may increase tenfold or more for cash flow hedging under fair-value accounting compared with a perfectly matched accounting system.

The Effect of Mandatory Disclosure on Market Inefficiencies: Evidence from Statement of Financial Accounting Standard Number 161

Prior research finds that unrealized gains/losses on cash flow hedges are negatively associated with future earnings, and that investors and analysts fail to anticipate this association. These studies speculate that this mispricing is due to either poor derivatives disclosures or the accounting model for cash flow hedges. We examine whether enhanced mandatory derivatives disclosures set forth in FAS 161 improve users’ understanding of firms’ hedging activities and offer three main findings. First, we find that this mispricing does not persist after FAS 161. Second, we find that the correction of mispricing is greatest when disclosure might help investors most. Finally, we find that analyst forecast accuracy improves after FAS 161. Overall, our results suggest that the enhanced mandatory derivative disclosures required by FAS 161 improved users’ understanding of the effects of derivative and hedging activities on future firm performance and firm value – and consequently mitigated investor mispricing.

Interest rate derivatives use in banking: Market pricing implications of cash flow hedges

Abstract We examine whether investors are able to fully anticipate the pricing implications of cash flow hedges in the banking industry. We show that mark-to-market adjustments on cash flow hedges are inversely related to future cash flows and that investors underestimate the extent of this inverse relation. Our evidence supports the notion that incomplete information on value relevant parameters makes it difficult for investors to accurately predict the effects of current cash flow hedge adjustments on future cash flows. Our results are also consistent with the evidence that investors have limited attention such that information, particularly information that is difficult to discern, is not fully reflected in stock prices. Thus, the additional disclosures mandated by regulatory agencies in the banking industry are not sufficient to overcome the challenges associated with incomplete information and investors’ limited attention.

Value Relevance of Comprehensive Income

AbstractIn this paper, we investigate the value relevance of comprehensive income and its components for a sample of 92 New Zealand companies over the period 2003–2010. We find a stronger association of aggregate comprehensive income with stock price and market returns relative to net income. The change in the asset revaluation reserve and the change in fair value of available‐for‐sale securities drive this association. However, foreign currency translation and cash flow hedges are also associated with prices and returns.

혼합잉여의 유형별 가치관련성에 관한 연구

This study investigates whether firm`s share prices correctly reflect two types of dirty surplus items in Korean capital market. The first of these is commonly referred to as “other comprehensive income,” which is a component of comprehensive income that is excluded from reported earnings, and therefore violates clean surplus accounting. The second accounting measure we consider is “hidden dirty surplus”, which arises when a firm issues or reacquires its own shares in a transaction that does not record the shares at fair market value. An Example this kind of transaction is a conversion of a bond into common stock at other than fair market value. Unlike other comprehensive income, which is readily observable from the comprehensive income statement under K-IFRS, hidden dirty surplus is unobservable. Therefore, it is very difficult for investor to estimate the valuation impact of equity transactions that give rise to hidden dirty surplus. As a result, hidden dirty surplus is less likely to be correctly priced than are other comprehensive income. Specifically, we compute other comprehensive income(OCI) as sum (1) the change in value of available-for-sale securities. (2) the foreign exchange gains and losses arising from translations of financial, (3) the effective portion of gains and losses on hedging instruments in a cash flow hedge, (4) the change in value of property, and (5) the actuarial gains and losses on defined benefit plans. Based on Landsman et al. (2011), we compute hidden dirty surplus(HDS) as the change in the book value of common equity, less OCI, less net income, plus dividends, less share price at middle of fiscal year times change in common shares outstanding. To achieve the afore-mentioned research objectives, we first assess whether investors properly value each of these two types of dirty surplus by estimating a residual income forecasting equation and an attendant valuation equation that includes both of these components, using financial statement and stock price data from 2011-2014. We next employ Carhart`s (1997) four-factor market model in order to see market-based financial performance measured by stock return incorporates these two components of dirty surplus. Using the four factor model, we analyze whether investors can obtain abnormal returns by holding long position in firms with relatively large OCI or HDS and short position in firms with relatively small OCI or HDS. The analysis yields following key findings. First, other comprehensive income are irrelevant for forecasting abnormal very comprehensive income in next period and setting stock prices. Second, hidden dirty surplus is also irrelevant for forecasting abnormal very comprehensive income in next period but investors appear to undervalue the HDS component of income, i. e., over-value equity. Third, hedge returns are insignificant when the sample firms are ranked based on the other comprehensive income, but it is positive and significant when the HDS is used to rank the sample firms. These results are suggest that investors fail to understand the lack of persistence of hidden dirty surplus, and therefore apparently over-valuing firms that have hidden dirty surplus.