Air Canada 2012 Annual Report Download - page 53

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2012 Management’s Discussion and Analysis
53
12. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT
Summary of “Gain (Loss) on Financial Instruments Recorded at Fair Value”
The following is a summary of “gain (loss) on financial instruments recorded at fair value” included in non-operating income
(expense) on Air Canada’s consolidated statement of operations for the periods indicated:
Fourth Quarter Full Year
(Canadian dollars in millions) 2012 2011 2012 2011
Fuel derivatives $(14) $ 1 $ (43) $ (26)
Prepayment option on senior secured notes 15 – 15 –
Interest rate swaps – (1) (1) (22)
Share forward contracts 3 (3) 5 (10)
Other 3 (2) 4 (5)
Gain (loss) on financial instruments recorded at fair value $7 $ (5) $ (20) $ (63)
Risk Management
Under its risk management policy, Air Canada manages its interest rate risk, foreign exchange risk, share based compensation
risk and market risk through the use of various interest rates, foreign exchange, fuel and other derivative financial instruments.
Air Canada uses derivative financial instruments only for risk management purposes, not for generating trading profit. As such,
any change in cash flows associated with derivative instruments is designed to be offset by changes in cash flows related to
the risk being hedged.
As noted below, Air Canada engages in derivative hedging in an effort to mitigate various risks. The derivative fair values
represent the amount of the consideration that could be exchanged in an arm’s length transaction between willing parties
who are under no compulsion to act. Fair value of these derivatives is determined using active markets, where available. When
no such market is available, valuation techniques are applied such as discounted cash flow analysis. Where practical, the
valuation technique incorporates all factors that would be considered in setting a price, including Air Canada’s own credit risk
and the credit risk of the counterparty.
Interest Rate Risk Management
Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes
in market interest rates.
Air Canada enters into both fixed and floating rate debt and leases certain assets where the rental amount fluctuates based on
changes in short-term interest rates. Air Canada manages interest rate risk on a portfolio basis and seeks financing terms in
individual arrangements that are most advantageous taking into account all relevant factors, including credit margin, term and
basis. The risk management objective is to minimize the potential for changes in interest rates to cause adverse changes in
cash flows to Air Canada. The temporary investment portfolio, which earns a floating rate of return, is an economic hedge for
a portion of the floating rate debt.
The ratio of fixed to floating rate obligations outstanding is designed to maintain flexibility in Air Canada’s capital structure
and is based upon a long-term objective of 60% fixed and 40% floating but allows the flexibility to 75% fixed in the short-
term to adjust to prevailing market conditions. The ratio at December 31, 2012, was 71% fixed and 29% floating, including
the effects of interest rate swap positions (69% and 31%, respectively, as at December 31, 2011).