What is the difference between a cash flow hedge and a fair value hedge?
A core Corporate Treasury interview question — asked in analyst and associate interviews across IB, PE, and the Big 4.
THE SHORT ANSWER
A cash flow hedge mitigates variability in future cash flows from a forecasted transaction or variable-rate instrument, with gains/losses in OCI reclassified to P&L when the hedged item affects earnings. A fair value hedge offsets changes in fair value of an existing asset/liability or firm commitment, with gains/losses in P&L. The key distinction is the risk being hedged: cash flow vs. fair value.
WHAT INTERVIEWERS LISTEN FOR
- ✓Cash flow hedge: variability in cash flows
- ✓Fair value hedge: changes in fair value
- ✓Accounting treatment: OCI vs. P&L
- ✓Hedged item type
COMMON MISTAKES
- ✗Saying both are same
- ✗Confusing with net investment hedge
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