A Simpler Approach

We disagree with the hedge-effectiveness testing method described in “Practical Issues in Implementing FASB 133” ( JofA, Mar.01, page 26). Our experience advising companies on interest rate risk and foreign-currency hedging transactions, and our related consulting work on applying FASB Statement no. 133, have led us to draw a substantially different conclusion—that while more than one approach may be employed, the simplest often is the best.

The article states that “the [dollar offset] method does not provide the best measure of a hedge’s expected effectiveness….A correlation analysis is a superior approach….” Our experience shows that choice of the most appropriate test method relies chiefly on the nature of the hedged risk and the type of hedging instrument used. (Statement no 133, in fact, says much the same—in paragraphs 62 and 386–390).

We assist with a great number of hedge transactions and find that in some cases regression or other statistical methods make sense. However, often they are overkill for interest rate hedges whereby all important terms are perfectly matched or only timing differences exist. For many of these situations, the accounting standards (Statement no. 133, paragraph 68, and the Derivatives Implementation Group Issue G9, for example) allow use of simple qualitative assessments that involve neither dollar offset nor statistical tests.

Jeff Kutz and Sandy Crawford
Chatham Financial Corp.
Kennett Square, Pennsylvania