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Navigate the complex world of currency management with our comprehensive dictionary of financial terms and definitions.

Effective Hedging Relationship

Hedging relationship effectiveness is a concept introduced by the hedge accounting standards, referring to the extent to which changes in the fair value of a hedged item are offset by opposite changes in the fair value of the financial derivative instrument intended to hedge it. An effective hedging relationship is one of the main requirements of the different standards for hedge accounting. Under hedge accounting, an effective hedging relationships need to meet three conditions: Economic relationship. There must be an inverse relationship between the change in the value of the hedged item and the change in the value of the hedging instrument. Credit risk. Changes in the credit risk of the hedging instrument or hedged item should not be large enough as to dominate the value changes associated with the economic relationship. Hedge ratio. The appropriate hedge ratio should be maintained throughout the life of the hedge.