Avon 2006 Annual Report Download - page 39

In August 2006, we entered into a one-year Japanese yen 11.0
billion ($92.9 at the exchange rate on December 31, 2006)
uncommitted credit facility (“yen credit facility”) with the Bank
of Tokyo-Mitsubishi UFJ, Ltd. Borrowings under the yen credit
facility bear interest at the yen LIBOR rate plus an applicable
margin. The yen credit facility is available for general corporate
purposes, including working capital and the repayment of out-
standing indebtedness. The yen credit facility was used to repay
the Japanese yen 9.0 billion note which came due in September
2006, as well as for other general corporate purposes. The yen
credit facility is designated as a hedge of our net investment in
our Japanese subsidiary. At December 31, 2006, $92.9 (Japanese
yen 11.0 billion) was outstanding under the yen credit facility.
At December 31, 2006, we were in compliance with all cove-
nants in our indentures (see Note 4, Debt and Other Financing).
Such indentures do not contain any rating downgrade triggers
that would accelerate the maturity of our debt.
ITEM 7A. QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT
MARKET RISK
The overall objective of our financial risk management program
is to reduce the potential negative effects from changes in for-
eign exchange and interest rates arising from our business activ-
ities. We may reduce our exposure to fluctuations in cash flows
associated with changes in interest rates and foreign exchange
rates by creating offsetting positions through the use of
derivative financial instruments and through operational means.
Since we use foreign currency rate-sensitive and interest rate-
sensitive instruments to hedge a certain portion of our existing
and forecasted transactions, we expect that any loss in value for
the hedge instruments generally would be offset by increases in
the value of the underlying transactions.
We do not enter into derivative financial instruments for trading
or speculative purposes, nor are we a party to leveraged
derivatives. The master agreements governing our derivative
contracts generally contain standard provisions that could trigger
early termination of the contracts in certain circumstances,
including if we were to merge with another entity and the cred-
itworthiness of the surviving entity were to be “materially weak-
er” than that of Avon prior to the merger.
Interest Rate Risk
Our long-term, fixed-rate borrowings are subject to interest rate
risk. We use interest rate swaps, which effectively convert the
fixed rate on the debt to a floating interest rate, to manage our
interest rate exposure. At December 31, 2006 and 2005, we
held interest rate swap agreements that effectively converted
approximately 30% and 60%, respectively, of our outstanding
long-term, fixed-rate borrowings to a variable interest rate based
on LIBOR. Avon’s total exposure to floating interest rates at
December 31, 2006 and December 31, 2005 was approximately
50% and 80%, respectively.
Our long-term borrowings and interest rate swaps 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, 2006, a hypothetical 50 basis point
change (either an increase or a decrease) in interest rates prevail-
ing at that date, sustained for one year, would not represent a
material potential change in fair value, earnings or cash flows.
This potential change was calculated based on discounted cash
flow analyses using interest rates comparable to our current cost
of debt.
Foreign Currency Risk
We operate globally, with operations in various locations around
the world. Over the past three years, approximately 65% to
75% of our consolidated revenue was derived from operations
of subsidiaries outside of the U.S. The functional currency for
most of our foreign operations is the local currency. We are
exposed to changes in financial market conditions in the normal
course of our operations, primarily due to international busi-
nesses and transactions denominated in foreign currencies and
the use of various financial instruments to fund ongoing activ-
ities. At December 31, 2006, the primary currencies for which
we had net underlying foreign currency exchange rate exposures
were the Argentine peso, Brazilian real, British pound, Canadian
dollar, Chinese renminbi, Colombian peso, the Euro, Japanese
yen, Mexican peso, Polish zloty, Russian ruble, Turkish lira and
Venezuelan bolivar.
We may reduce our exposure to fluctuations in cash flows asso-
ciated with changes in foreign exchange rates by creating off-
setting positions through the use of derivative financial
instruments.
Our hedges of our foreign currency exposure are not designed
to, and, therefore, cannot entirely eliminate the effect of
changes in foreign exchange rates on our consolidated financial
position, results of operations and cash flows.
Our foreign-currency financial instruments were analyzed at
year-end to determine their sensitivity to foreign exchange rate
changes. Based on our foreign exchange contracts at
December 31, 2006, the impact of a 10% appreciation or 10%
depreciation of the U.S. dollar against our foreign exchange
contracts would not represent a material potential change in fair
value, earnings or cash flows. This potential change does not
consider our underlying foreign currency exposures. The hypo-
thetical impact was calculated on the open positions using
A V O N 2006 33