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A cash flow hedge is a risk management strategy used by companies to protect against fluctuations in future cash flows due to changes in market conditions, such as interest rates, currency exchange rates, or commodity prices. The hedge involves using financial instruments, such as derivatives, to offset potential cash flow variability. For example, a company expecting to make future payments in a foreign currency might use a currency forward contract to lock in a favorable exchange rate, reducing the risk of currency fluctuations affecting cash flows.
A company that expects to pay €1 million in six months might use a cash flow hedge by entering into a forward contract to lock in the current exchange rate, ensuring that currency fluctuations do not impact its cash flows.
• A cash flow hedge protects against future cash flow variability caused by market fluctuations.
• Common hedges involve using derivatives like forward contracts, futures, or swaps.
• It helps businesses manage risks related to interest rates, currencies, or commodities.
The purpose is to protect against fluctuations in cash flows due to changes in market conditions, such as currency exchange rates or interest rates.
Common instruments include forward contracts, futures, options, and swaps.
It reduces financial risk by locking in favorable terms and protecting against adverse market movements, ensuring more predictable cash flows.
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