Hedge Accounting as a Strategic Tool inFinancial Risk Management: A Review

Abstract

This paper examines the financial risks faced by businesses by determining the meaning of risk and types, and investigates the management of financial risk in the light of hedge accounting techniques. Thus, this paper investigates hedge accounting and its role in the protection from and hedging of risks to which businesses are exposed. This necessitates a departure from today’s largely transactions-based model, which generally does not measure assets or liabilities at fair value and recognizes the effects of price changes only on disposition or settlement. The paper examines how the use of hedge accounting can help to achieve efficient management of financial risk in businesses. The paper attempts to answer four research questions: 1. What is the structure of enterprise risk types and purposes? 2. How does one choose the appropriate strategy for the management of financial risk? 3. Why hedge? 4. What is the objective of focusing on the operations of hedge accounting? The primary findings are that the use of hedge derivative instruments can have significant effects on other corporate decisions, such as the level and maturity of debt, dividend policy, holdings of liquid assets, and the extent to which hedging is utilized. Finally, the hedge accounting strategy should be designed to balance the economic effectiveness of the hedge with the cost of the hedge.

Keywords:risk management, enterprise risks, financial instruments, hedge accounting