Avon 2001 Annual Report Download - page 15

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Avon’s long-term borrowings, interest rate swaps
and treasury lock agreement were analyzed at year end to
determine their sensitivity to interest rate changes. Based
on the outstanding balance of all these financial instru-
ments at December 31, 2002, a hypothetical 50 basis point
change (either an increase or a decrease) in interest rates
prevailing at that date, sustained for one year, would not
represent a material potential change in fair value, earn-
ings or cash flows. This potential change was calculated
based on discounted cash flow analyses using interest rates
comparable to Avon’s current cost of debt. In 2002, Avon
did not experience a material change in fair value, earnings
or cash flows associated with changes in interest rates.
Foreign Currency Risk > Avon is exposed to changes in
financial market conditions in the normal course of its
operations, primarily due to international businesses and
transactions denominated in foreign currencies and the use
of various financial instruments to fund ongoing activities.
Avon uses foreign currency forward contracts and
options to hedge portions of its forecasted foreign currency
cash flows resulting from intercompany royalties, inter-
company loans, and other third-party and intercompany
foreign currency transactions where there is a high proba-
bility that anticipated exposures will materialize. These
contracts have been designated as cash flow hedges. At
December 31, 2002, the primary currencies for which
Avon has net underlying foreign currency exchange rate
exposure are the U.S. dollar versus the Argentine peso,
Brazilian real, British pound, Canadian dollar, the euro,
Japanese yen, Mexican peso, Philippine peso, Polish zloty,
Russian ruble and Venezuelan bolivar.
Avon also enters into foreign currency forward con-
tracts and options to protect against the adverse effects
that exchange rate fluctuations may have on the earnings
of its foreign subsidiaries. These derivatives do not qualify
for hedge accounting and therefore, the gains and losses on
these derivatives have been recognized in earnings each
reporting period. Avon’s hedges of its foreign currency
exposure cannot entirely eliminate the effect of changes in
foreign exchange rates on Avon’s consolidated financial
position, results of operations and cash flows.
Avon uses foreign currency forward contracts and
foreign currency denominated debt to hedge the foreign
currency exposure related to the net assets of certain of its
foreign subsidiaries. During 2001, Avon entered into loan
agreements and notes payable to borrow Japanese yen to
hedge Avon’s net investment in its Japanese subsidiary (see
Note 4, Debt and Other Financing). During 2001, Avon
also entered into foreign currency forward contracts to
hedge its net investment in its Mexican subsidiary. These
forward contracts were settled in 2002. For the years
ended December 31, 2002 and 2001, net losses of $.8 and
net gains of $5.1, respectively, related to the effective por-
tion of these hedges were included in foreign currency
translation adjustments within Accumulated other com-
prehensive loss on the Consolidated Balance Sheets.
At December 31, 2002, Avon held foreign currency
forward and option contracts to buy and sell foreign
currencies, including cross-currency contracts to sell one
foreign currency for another, with notional amounts in
U.S. dollars as follows:
Buy Sell
Argentine peso $ — $ 2.7
Brazilian real — 24.0
British pound 6.6 31.1
Canadian dollar — 27.4
Czech koruna — 3.7
Euro 54.8 13.9
Japanese yen 17.4 18.0
Mexican peso — 16.5
Philippine peso — 4.0
Polish zloty 1.2 17.1
Taiwanese dollar — 5.3
Other currencies 1.2 8.3
Total $81.2 $172.0
At December 31, 2002, certain Avon subsidiaries
held U.S. dollar denominated assets, primarily to minimize
foreign-currency risk and provide liquidity. These sub-
sidiaries included Mexico ($23.5), Argentina ($12.4),
Venezuela ($6.8) and Brazil ($7.6). For the years ended
December 31, 2002 and 2001, Other (income) expense, net
included net transaction gains of $27.8 and $8.0, respec-
tively, related to these U.S. dollar denominated assets.
Avon’s foreign-currency financial instruments were
analyzed at year end to determine their sensitivity to for-
eign exchange rate changes. Based on the Company’s for-
eign exchange contracts at December 31, 2002, the
impact of a 10% appreciation or 10% depreciation of the
U.S. dollar against the Company’s foreign exchange con-
tracts would not represent a material potential change in
fair value, earnings or cash flows. This potential change
does not consider the underlying foreign currency expo-
sures of the Company. The hypothetical impact was calcu-
lated on the combined option and forward positions using
forward rates at December 31, 2002, adjusted for an
assumed 10% appreciation or 10% depreciation of the
U.S. dollar against the foreign contracts. The impact of
payoffs on option contracts is not significant to this calcu-
lation. In 2002, net foreign exchange gains associated with
the Company’s foreign exchange contracts did not repre-
sent a material change in fair value, earnings or cash flows.
Equity Price Risk > Avon is exposed to equity price fluc-
tuations for investments included in the grantors trust
(see Note 10, Employee Benefit Plans). A 10% change
(either an increase or decrease) in equity prices would not
be material based on the fair value of equity investments
as of December 31, 2002.
Credit Risk > Avon attempts to minimize its credit expo-
sure to counterparties by entering into interest rate swap,