Air Canada 2008 Annual Report Download - page 56

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2008 Air Canada Annual Report
56
converted from a fixed interest rate of 5.208% and 5.640% to a floating interest rate. These derivative instruments
were not designated as hedges for accounting purposes and were fair valued on a quarterly basis. In 2008, a gain of
$4 million was recorded in gain on financial instruments recorded at fair value related to these derivatives. These
swaps were terminated on October 1, 2008 with a fair value of $4 million in favour of the Corporation.
• AsatDecember31,2008,theCorporationhadenteredintotwointerestrateswapagreementswithtermsofJuly
2022 and January 2024 relating to two Boeing 767 aircraft financing agreements with an aggregate notional value
of $118 million (US$96 million) ($103 million (US$104 million) in 2007). These swaps convert the lease payments
on the two aircraft leases from fixed to floating rates. The fair value of these contracts as at December 31, 2008
was $21 million in favour of the Corporation ($7 million in favour of the Corporation in 2007). These derivative
instruments have not been designated as hedges for accounting purposes and are fair valued on a quarterly basis.
In 2008, a gain of $14 million was recorded in gain on financial instruments recorded at fair value related to these
derivatives ($3 million in 2007).
• The Corporation enters into forward interest rate agreements to manage the risks associated with interest rate
movement on US dollar and Canadian dollar floating rate debt and investments. In 2006, the Corporation entered
into 19 interest rate swaps with a notional value of US$414 million to receive floating rates and pay a weighted
average fixed rate of 5.81% for the debt to be arranged in relation to the financing of Embraer 190 aircraft between
June 2006 and February 2008. The swaps had 15-year terms from the expected delivery date of the aircraft and their
maturities ranged from June 2021 to December 2022. The Corporation settled the interest rate swaps upon delivery
of the related aircraft. The Corporation did not apply hedge accounting to these derivative instruments. During 2008,
the Corporation’s one remaining Embraer 190 aircraft interest rate swap contract matured, with a fair value of $2
million in favour of the counterparty ($2 million in favour of the counterparty in 2007). No gain or loss was recorded
in 2008 (a net loss of $10 million on 11 contracts was recorded in 2007).
Interest income includes $47 million in 2008 ($84 million in 2007) related to cash, cash equivalents, short-term investments
and collateral deposits for fuel derivatives which are classified as held-for-trading. Interest expense reflected on Air Canada’s
consolidated statement of operations relates to financial liabilities recorded at amortized cost.
ForeignExchangeRisk
Foreign exchange risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of
changes in foreign exchange rates.
The Corporation’s risk management objective is to reduce cash flow risk related to foreign denominated cash flows.
Air Canada’s cash inflows are primarily in Canadian dollars, while a large portion of its outflows are in US dollars. This
unbalanced mix results in an annual US dollar shortfall from operations. In order to mitigate this imbalance, Air Canada
has adopted the practice of converting excess revenues from offshore currencies into US dollars. In 2008, this conversion
generated coverage of approximately 30% of the imbalance. The remaining 70% was covered through the use of a variety
of foreign exchange derivatives, including spot transactions, which had maturity dates corresponding to the forecasted
shortfall dates. The level of foreign exchange derivatives expiring at any one point in time is dependent upon a number of
factors, which include the amount of foreign revenue conversion available, US dollar net cash flows, as well as the amount
attributed to aircraft and debt payments. As a result of the significant drop in the price of fuel, the Corporation’s US dollar
requirements have also declined proportionally.
The majority of the Corporation’s outstanding debt is denominated in US dollars. The US dollar debt acts as an economic
hedge against the related aircraft, which is routinely purchased, leased or subleased to third parties, and sold by Air Canada
in US dollars.
The Corporation is also exposed to foreign exchange risk on foreign currency denominated trade receivables and foreign
currency denominated net cash flows.
As noted below, given the substantial depreciation of the Canadian dollar during the fourth quarter of 2008, the Corporation
chose to terminate certain of its foreign currency contracts in order to realize on the positive mark-to-market cash value
of these derivatives. Consistent with the Corporation’s risk management objectives, new derivative positions are being
entered into at current foreign exchange rates.