Balance sheet risk – also known as transaction accounting risk – is the most commonly hedged currency risk, resulting from monetary transactions recorded on the balance sheet in a currency other than an entity’s functional currency. Balance sheet hedging mitigates foreign currency gains and losses caused by the difference in currency rates. The hedge essentially neutralizes the P&L.

This type of hedging is common, but so are certain weaknesses that can slip through the cracks and create more risk or ineffective hedge results. Sometimes, companies mitigate certain aspects of currency risk while creating others. Other times, hidden aspects of a hedge program can cause problems.

There can be certain signs that a balance sheet hedge program is not what it seems. Here are five questions you should be asking about your balance sheet hedging to see how well it’s performing.

1. Are you delivering regularly on your hedge contracts?

2. Are you converting cash at the hedge rate?

3. Are you hedging away local currency?

4. Can you explain away residual foreign currency gains & losses?

5. Are your inter-company hedges uneconomic?

Find out why these questions are important.

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