Vector Risk supports hedge accounting calculations to comply with IFRS 13 (consistent with the new fair value requirements), IFRS 9 (to comply with the new hedge accounting requirements) and IFRS 7 (to calculate and report sensitivity results), all of which are published by the International Financial Reporting Standards Board (IASB).
Hedge Effectiveness using Dollar Offset
The dollar offset method involves comparing past changes in the fair value or cash flows of the hedged item, attributable to the hedged risk, with past changes in the fair value or cash flows of the hedging instrument. The dollar offset method can be performed either on a stand-alone ‘period-by-period’ basis or on a cumulative basis from inception, depending on what has been established in the hedge documentation.
Under the cumulative basis (referred to as the cumulative change method or cumulative ratio dollar offset method), even
if a hedge is not highly effective in a particular period, hedge accounting is not precluded if the effectiveness remains
sufficient on a cumulative basis. Measuring effectiveness on a cumulative basis may reduce the risk of a hedge becoming ineffective in a particular period, and is therefore the more common method in practice.
Regression Analysis
Regression analysis involves demonstrating a high statistical correlation between the fair value or cash flows of the hedged
item and those of the hedging instrument; for example, using a statistical model to analyse this correlation for a given historic period.
An example of regression analysis could involve calculating the change in fair value of the hedging instrument using a
minimum of XX historical market data (e.g. interest rate) scenarios, and the change in fair value of a hypothetically
perfect derivative with a fair value of zero at hedge designation date using the same XX historical (interest rate) scenarios.
The data points will be the fair value changes in the actual derivative compared to fair value changes in the hypothetical
derivative with a zero fair value as at the particular hedge effectiveness testing date.
The hedge will be considered to be highly effective prospectively and retrospectively if the regression shows an Rsquare
of 80% or higher, the 95% confidence interval for the estimate of the slope is between 0.8 to 1.25, F-stat > F- crit 0.05
and T-stat < T- crit 0.05.