Cash Flow Hedge

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.

Example

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.