Chapter A, Problem 1E

To determine

Derivatives: Derivatives are some financial instruments which are meant for managing risk and safeguard the risk created by other financial instruments. These financial instruments derive the values from the future value of underlying security or index. Some examples of derivatives are forward contracts, interest rate swaps, futures, and options.

Hedging: This is the business deal entered into, by a company to produce exposure or coverage over the exposure caused by the existing deal. In simple terms, this is the transaction which produces gains to cover the losses produced by existing transaction.

Fair value hedge: If the company uses any derivative to cover the risk due to fair value changes of asset, liability, or a commitment, the derivative is classified as fair value hedge. This type of hedge focusses to control the risk due to future price changes.

Cash flow hedge: If a company uses any derivative to cover the risk due to cash flow changes of asset, or a liability, or a commitment to buy or sell, the derivative is classified as cash flow hedge. This type of hedge focusses to control the risk due to current price changes, like more cash outflow, or less cash inflow.

Foreign currency hedge: A multinational company faces the risk due to changes in foreign currency rate, when the transactions of its foreign operations are denominated in foreign currency, and such transactions require settlements through translation. The derivative used to hedge such type of foreign currency risk is designated as foreign currency hedge.

To indicate: The type of hedge against the activity given