Question

Formal documentation of a hedging relationship must explain how the hedging instrument's effectiveness will be measured.

True or false?

Answer 1

Formal documentation of a hedging relationship must explain how the hedging instrument's effectiveness will be measured. The given statement "Formal documentation of a hedging relationship must explain how the hedging instrument's effectiveness will be measured." is true.

Step-by-step explanation:

Formal documentation of a hedging relationship includes a crucial element—the explanation of how the effectiveness of the hedging instrument will be measured.

This is pivotal as it establishes a framework for evaluating the success of the hedging strategy. By outlining specific measurement criteria, parties involved gain a standardized method to assess whether the hedging instrument is achieving its intended risk mitigation goals.

This clarity is vital for informed decision-making, as it enables stakeholders to identify any deviations from the expected outcomes and prompts timely adjustments to the hedging approach.

Overall, documenting the measurement process enhances transparency, accountability, and the overall efficacy of the hedging relationship, fostering a more robust risk management framework.

The given statement "Formal documentation of a hedging relationship must explain how the hedging instrument's effectiveness will be measured." is true.

Answer 2

The statement is true; formal documentation must detail how a hedging instrument's effectiveness will be assessed to manage exchange rate risk for firms.

Step-by-step explanation:

It is true that the formal documentation of a hedging relationship must explain how the hedging instrument's effectiveness will be measured. This is essential for firms to manage their risk, particularly when dealing with foreign exchange uncertainties. For example, a U.S. firm exporting to France and receiving payments in euros is exposed to the risk of fluctuating exchange rates. By entering into a hedging contract with a financial institution or brokerage company, the firm can lock in an exchange rate, thereby knowing the exact value of their future revenue in U.S. dollars. Documentation should include details on how the hedge will be assessed for effectiveness to ensure that the hedge aligns with the company's risk management objectives.