Friday, May 1, 2009

Hedging: An Irregular Verb

Irregular verbs are the bane of people learning a foreign language. I still shudder at the thought of learning irregular French verbs in high school.

For those with poor memories of their schooling, irregular verbs change in a unique manner as their usage changes. For example, the verb "to be" changes in the following pattern:

  • I am
  • You are
  • He/she/it is
  • We are
  • You are
  • They are
But enough of the English lesson. The TV series Yes Minister and its sequel Yes Prime Minister both created jokes out of irregular verbs. In these series, the Minister's principal private secretary, Bernard Woolley (played by Derek Fowlds) regularly invents irregular verb constructions for humorous impact. Following his lead, I am proposing a new irregular verb: "to hedge".

  • I hedge
  • You speculate
  • He/she/it sells goods that do not belong to him/her/it
  • We manage open positions
  • You insure
  • They go to jail for fraud
The problem with hedging is that it is frequently only the intent of the actor which distinguishes a hedging transaction from a speculative transaction - particularly in relation to an anticipated future commitment or receipt. This is a concern for accounting as gains and losses from hedge transactions are not recorded as part of operating income but gains and losses from speculation are. The difficulty of identifying the motive means that management can selectively choose whether to record gains or losses from derivatives transactions as part of income or not. The possibilities for gaming this should be obvious.

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