A derivative is a financial security whose value comes from (or is derived from) the value of another security. Some speculators use derivatives for speculation. More commonly, a company will use a derivative to reduce risk. Two of the most common types of derivatives used to reduce risk are hedge and swaps.

The FASB allows special accounting for two types of hedges.

Describe the two types of hedges. Respond in 3-5 sentences.

(1) Fair value hedge

(2) Cash flow hedge