Hedging involves the designation of hedging instruments so that their change in fair value is offset by changes in fair value or cash flows of hedged items. In other words, it is an attempt to remove risk.
There are two types of hedge.
A fair-value hedge addresses the risk that the fair value of an asset or liability could change.
A cash-flow hedge addresses the potential variability of future cash flows.
Under a fair value hedge, the gain/loss in re-measuring the hedging instrument is recognised in profit and loss, along with the gain or loss on the hedged item.
Under a cash-flow hedge, the portion of the gain/loss on the hedging instrument that is determined to be an effective hedge (more than matched by the change in value of the hedged cash flow, for instance) is recognised directly in equity, while the ineffective portion is recognised in profit and loss.
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