Overview

Derivatives are financial contracts whose value is tied in some way to an underlying financial asset. They are generally required to be valued at fair value using one of the following methods (see hedge accounting below for the exceptions)

• Quoted prices
• Estimated by an accepted model and observable inputs
• Discounted cash flow calculation

Changes in the value of a derivative flow throw to the earnings, which means that derivative volatility will show up as earnings volatility.

Hedge Accounting

Hedge Accounting is an accounting treatment of a derivative that differs from the standard fair value treatment. In order to use hedge accounting for a derivative, the derivative in question must qualify for hedge accounting according the hedge accounting rules.