ABSTRACT
Risk is the primary driver of value for any business. In order for a business to be profitable and create value, it must generate returns; and returns are compensation for the risks a business takes. This chapter discusses the economic motivations for hedging with derivatives. It also discusses the accounting for derivatives and hedging. The chapter explains the financial statement analysis challenges that arise when firms hedge with derivatives. In a fair value hedge, the hedged item has a measurement basis other than fair value, creating a mismatch with the hedging instrument that is reported at fair value. Techniques managers can employ to help users of the financial statements better map the accounting for derivatives into firm performance and value. Specifically, firms record derivatives at fair value at each balance sheet date, and record changes in fair value either as part of net income or part of shareholders' equity.
