Accounting for corporate finance: hedging: cash flow hedge
This guidance applies to companies which apply IFRS, New UK GAAP or FRS 26.
Cash flow hedges
The following are examples of cash-flow hedges. For a definition of a cash-flow hedge, see CFM27120.
A company borrows £10 million at LIBOR plus 2%. Changes in LIBOR will affect the company’s future cash flows, as the amount it must pay will vary as the LIBOR rate moves. The company may hedge this risk by entering into an interest rate swap, in which it pays a fixed rate of interest but receives a variable one.
A chocolate manufacturer assesses it as highly probable that it will buy 5,000 tonnes of cocoa in six months’ time, paying the spot rate at the time it places the order. Changes in cocoa prices will affect its future cash flows. The manufacturer may therefore purchase cocoa bean futures to hedge the exposure by ‘fixing’ the price it will pay.