What is a Hedging Instrument?

A hedging instrument is a designated financial instrument whose fair value or related cash flows should offset changes in the fair value or cash flows of a designated hedged item. A hedged item is an asset, liability, commitment, highly probable transaction, or investment in a foreign operation that exposes an entity to changes in fair value or cash flows, and is designated as being hedged.

Cost-Effectiveness of a Hedging Instrument

Many businesses do not use hedging instruments, because their cost may exceed the benefit to be gained from their use. This is most commonly the case when the risk being hedged against has a high probability of occurrence, which increases the cost of the hedge.