The Fair Value Of Cash Flow Hedges, Future Profitability And Stock Returns

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Executive Summary

The author examine the information content of unrealized cash flow hedge gains/losses for future profitability and stock returns. An unrealized gain on a cash flow hedge suggests that the price of the underlying hedged item (i.e. commodity price, foreign currency exchange rate or interest rate) moved in a direction that negatively affects the firm. Based on this inverse relation, the author find that unrealized cash flow hedge gains/losses are negatively associated with future gross margin. This association is weaker for firms that have the ability to pass input price changes through to customers.

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