Archer Daniels Midland 2006 Annual Report Download - page 36

34 Archer Daniels Midland Company
MANAGEMENT’S DISCUSSION OF
OPERATIONS AND FINANCIAL CONDITION - JUNE 30, 2006 (CONTINUED)
Valuation of Marketable Securities and
Investments in Affiliates
The Company classifies the majority of its marketable securities
as available-for-sale and carries these securities at fair value.
Investments in affiliates are carried at cost plus equity in
undistributed earnings. For publicly traded securities, the fair value
of the Company’s investments is readily available based on quoted
market prices. For non-publicly traded securities, management’s
assessment of fair value is based on valuation methodologies
including discounted cash flows and estimates of sales proceeds. In
the event of a decline in fair value of an investment below carrying
value, management may be required to determine if the decline in
fair value is other than temporary. In evaluating the nature of a
decline in the fair value of an investment, management considers the
market conditions, trends of earnings, discounted cash flows, trading
volumes, and other key measures of the investment as well as the
Company’s ability and intent to hold the investment. When such a
decline in value is deemed to be other than temporary, an impairment
loss is recognized in the current period operating results to the extent
of the decline. See Notes 2 and 4 to the Company’s consolidated
financial statements for information regarding the Company’s
marketable securities and investments in affiliates. If management
used different estimates and assumptions in its evaluation of these
marketable securities, then the Company could recognize different
amounts of expense over future periods.
The Company is a limited partner in various private equity funds
which invest primarily in emerging markets. The Company accounts
for these limited partnerships using the equity method of accounting.
Therefore, the Company is recording in the consolidated statement of
earnings its proportional share of the limited partnerships’ net income
or loss. The limited partnerships value their investments at fair value.
Thus, unrealized gains and losses related to the change in fair
value of these investments are recorded in the limited partnerships’
statements of earnings. The valuation of these investments, as
determined by the general partner, can be subjective, and the values
may vary significantly. Some of the factors causing the subjectivity
and volatility of these valuations include the illiquidity and minority
positions of these investments, currency exchange rate fluctuations,
less-regulated securities exchanges, and the inherent business risks
and limitations present in the emerging market countries. The
Company records the results of these limited partnerships based on
the information provided to the Company by the general partner.
Due to the subjectivity and volatility in valuing these investments, the
fair value of these investments, and thus the Company’s results, could
vary significantly over future periods.
MARKET RISK SENSITIVE INSTRUMENTS
AND POSITIONS
The market risk inherent in the Company’s market risk sensitive
instruments and positions is the potential loss arising from adverse
changes in commodities futures prices, marketable equity security
prices, market prices of limited partnerships’ investments, foreign
currency exchange rates, and interest rates as described below.
Commodities
The availability and price of agricultural commodities are subject
to wide fluctuations due to unpredictable factors such as weather,
plantings, government (domestic and foreign) farm programs
and policies, changes in global demand resulting from population
growth and changes in standards of living, and global production
of similar and competitive crops. To reduce price risk caused by
market fluctuations, the Company generally follows a policy of using
exchange-traded futures and options contracts to minimize its net
position of merchandisable agricultural commodity inventories and
forward cash purchase and sales contracts. The Company will also
use exchange-traded futures and options contracts as components of
merchandising strategies designed to enhance margins. The results
of these strategies can be significantly impacted by factors such
as the volatility of the relationship between the value of exchange-
traded commodities futures contracts and the cash prices of the
underlying commodities, counterparty contracts defaults, and
volatility of freight markets. In addition, the Company from
time-to-time enters into derivative contracts which are designated
as hedges of specific volumes of commodities that will be purchased
and processed, or sold, in a future month. The changes in the
market value of such futures contracts have historically been, and
are expected to continue to be, highly effective at offsetting changes
in price movements of the hedged item. Gains and losses arising
from open and closed hedging transactions are deferred in other
comprehensive income, net of applicable taxes, and recognized as a
component of cost of products sold in the statement of earnings when
the hedged item is recognized.
A sensitivity analysis has been prepared to estimate the Company’s
exposure to market risk of its daily net commodity position. The
Company’s daily net commodity position consists of inventories,
related purchase and sale contracts, and exchange-traded futures
contracts, including those contracts used to hedge portions of
production requirements. The fair value of such daily net commodity
position is a summation of the fair values calculated for each
commodity by valuing each net position at quoted futures prices.
Market risk is estimated as the potential loss in fair value resulting
from a hypothetical 10% adverse change in such prices. Actual results
may differ.