Abstract
This article explains three useful methods for testing hedge effectiveness under FAS 133: the 80/125 test, the regression test, and the variance-reduction test. The article compares the tests and discusses their use in both prospective and retrospective testing. It also illustrates the practical application of these tests using an example drawn from the oil and gas industry. The example illustrates how to use the dollar-offset method to determine and account for the actual hedge ineffectiveness on a quarterly basis.
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