Canon 2002 Annual Report Download - page 73

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71
(18) Derivatives and Hedging Activities
Risk management policy
Canon operates internationally which exposes Canon to the risk
of changes in foreign exchange rates and interest rates.
Derivative financial instruments are comprised principally of
foreign exchange contracts and interest rate swaps utilized by
the Company and certain of its subsidiaries to reduce these
risks. Canon assesses foreign currency exchange rate risk and
interest rate risk by continually monitoring changes in these
exposures and by evaluating hedging opportunities. Canon does
not hold or issue derivative financial instruments for trading
purposes. Canon is also exposed to credit-related losses in the
event of non-performance by counterparties to derivative
financial instruments, but it is not expected that any
counterparties will fail to meet their obligations, because most of
the counterparties are internationally recognized financial
institutions and contracts are diversified into a number of major
financial institutions.
Foreign currency exchange rate risk management
The major manufacturing bases of Canon are located in Japan
and Asia. The sales generated from overseas are mainly
denominated in U.S. dollar or Euro. Therefore, Canon’s
international operations expose Canon to the risk of changes in
foreign currency. Canon uses foreign exchange contracts to
manage certain foreign currency exchange exposures principally
from the exchange of U.S. dollar and Euro into Japanese yen.
These contracts are primarily used to hedge the foreign currency
exposure of forecasted intercompany sales which are
denominated in foreign currencies. In accordance with Canon’s
policy, a specific portion of foreign currency exposure resulting
from forecasted intercompany sales are hedged using foreign
exchange contracts which principally mature within three
months.
Interest rate risk management
Canon’s exposure to the market risk of changes in interest rates
relates primarily to its debt obligations. The fixed-rate debt
obligations expose Canon to variability in their fair values due to
change in interest rates. To manage the variability in the fair
values caused by interest rate changes, Canon enters into
interest rate swaps, when it is determined to be appropriate
based on market conditions. The interest rate swaps change the
fixed-rate debt obligations to variable-rate debt obligations by
entering into receive-fixed, pay-variable interest rate swaps. The
hedging relationship between the interest rate swaps and its
hedged debt obligations is highly effective in achieving offsetting
changes in fair values resulting from interest rate risk.
Fair value hedge
Derivative financial instruments designated as fair value hedges
principally relate to interest rate swaps associated with fixed rate
debt obligations. Changes in fair values of the hedged debt
obligations and derivative instruments designated as fair value
hedges of these debt obligations are recognized in other
income (deductions). There is no hedging ineffectiveness or net
gains or losses excluded from the assessment of hedge
effectiveness for the years ended December 31, 2002 and
2001 as the critical terms of the interest rate swaps match the
terms of the hedged debt obligations.
Cash flow hedge
Changes in the fair value of foreign exchange contracts
designated and qualifying as cash flow hedges of forecasted
intercompany sales are reported in accumulated other
comprehensive income (loss). These amounts are subsequently
reclassified into earnings through other income (deductions) in
the same period as the hedged items affect earnings. All the
accumulated other comprehensive income (loss) at end of year
are substantially expected to be recognized in earnings over the
next twelve months. Canon excludes the time value component
of the hedging instruments from the assessment of hedge
effectiveness.
The effective portions of changes in the fair value of foreign
exchange contracts designated as cash flow hedges and reported
in accumulated other comprehensive income (loss), net of the
related tax effect, are losses of ¥610 million ($5,084 thousand)
and ¥6,465 million for the years ended December 31, 2002 and
2001. The amounts which were reclassified out of accumulated
other comprehensive income (loss) into other income
(deductions), net of the related tax effect, are net losses of
¥2,699 million ($22,492 thousand) and ¥4,042 million for the
years ended December 31, 2002 and 2001. The amounts of the
hedging ineffectiveness is not material for the years ended
December 31, 2002 and 2001. The sum of the amount of net
gains or losses excluded from the assessment of hedge
effectiveness which are also recorded in other income
(deductions), net of the related tax effect, are net gains of ¥668
million ($5,567 thousand) and ¥1,907 million for the years
ended December 31, 2002 and 2001.