ADT 2005 Annual Report Download - page 193

TYCO INTERNATIONAL LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
16. Financial Instruments (Continued)
The Company’s derivative financial instruments present certain market and counterparty risks;
however, concentration of counterparty risk is mitigated as Tyco deals with a variety of major banks
worldwide with long-term Standard & Poor’s and Moody’s credit ratings of A/A2 or higher. In addition,
only conventional derivative financial instruments are utilized, thereby affording optimum clarity as to
the market risk. None of the Company’s derivative financial instruments outstanding at year end would
result in a significant loss to the Company if a counterparty failed to perform according to the terms of
its agreement. At this time, the Company does not require collateral or other security to be furnished
by the counterparties to its derivative financial instruments.
Interest Rate Exposures
The Company enters into interest rate swap agreements to manage its exposure to interest rate
risk. Under these agreements, the Company receives fixed rates of interest ranging from 6% to 6.75%
and pays floating rates of interest based on six month LIBOR. At September 30, 2005, the Company
had interest rate swaps in a net gain position of $20 million designated as fair value hedges with
expiration dates in 2011 and 2013. The mark-to-market effects of both the interest rate swap
agreements and the underlying debt obligations were recorded in interest expense and are directly
offsetting to the extent the hedges are effective.
In addition, the Company enters into interest rate and foreign currency swap agreements (‘‘cross
currency swaps’’) to manage its exposure to interest rate risk and foreign currency exposure on loans
denominated in foreign currency. Under these agreements, the Company receives a fixed rate of
interest of 6.5% and pays floating rates of interest based on six month LIBOR. At September 30, 2005,
the Company had interest rate and foreign currency swap agreements in a net gain position of
$70 million designated as a fair value hedge with an expiration date in 2011. The mark-to-market
effects on the interest rate and foreign currency swaps were recorded in interest expense and selling,
general and administrative expense, respectively, and were directly offsetting to the extent the hedges
were effective.
Foreign Currency Exposures
The Company hedges its net investment in certain foreign operations. Included in the cumulative
translation adjustment component of other comprehensive income was a net gain of $31 million
($24 million after tax) and a net loss of $194 million ($142 million after tax) at September 30, 2005 and
2004, respectively.
The Company uses forward agreements to hedge its exposure to foreign currency exchange rates
on raw material purchases. These forward agreements are designated as cash flow hedges. Gains and
losses resulting from these hedges, the amounts of which are not material in any period presented, are
recorded in other comprehensive income. Amounts are reclassified from other comprehensive income
to earnings and recorded as an adjustment to cost of sales when the underlying transaction impacts
earnings.
Tyco uses various options, swaps, and forwards not designated as hedging instruments, to manage
foreign currency exposures on accounts and notes receivable, accounts payable, intercompany loan
balances and forecasted transactions denominated in certain foreign currencies. At September 30, 2005,
the Company had recorded net liabilities of $134 million related to these transactions. The carrying
value of financial instruments at September 30, 2005 approximates fair value.
2005 Financials 117