In relation to a hedging instrument/ hedged item and corresponding accounting treatment, it describes the situation where the cumulative change in the hedging instrument is more than the change in the hedged item (as measured in monetary or financial terms). Such a situation arises due to the standard size of contracts being used for the purpose of hedging.
For example, a transaction is said to be over-hedged if it involves the use of a futures or option position that covers the total cash market position beyond the required level, if the hedge is set up as a static hedge (that does not change over time). However, the value of the original position can divert, over time, from the value of the futures contract that was used as a hedge. This situation may result in an over-hedged position.
A dynamic hedge is usually used as a remedy to over-hedging, by frequent rebalancing of the hedge over time.
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