Capital One 2014 Annual Report Download - page 223

NOTE 10—DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Use of Derivatives
We manage our asset and liability position and market risk exposure in accordance with prescribed risk management
policies and limits established by our Market and Liquidity Risk Policy which is approved by our Board of Directors.
Our primary market risk stems from the impact on our earnings and economic value of equity from changes in
interest rates and, to a lesser extent, changes in foreign exchange rates. We employ several techniques to manage
our interest rate sensitivity, which include changing the duration and re-pricing characteristics of various assets and
liabilities by using interest rate derivatives. Our current asset and liability management policy also includes the use
of derivatives to hedge foreign currency denominated transactions to limit our earnings and capital ratio exposure
to foreign exchange risk. We execute our derivative contracts in both the over-the-counter (“OTC”) and exchange-
traded derivative markets. The majority of our derivatives are interest rate swaps. In addition, we may use a variety
of other derivative instruments, including caps, floors, options, futures and forward contracts, to manage our interest
rate and foreign exchange risk. We offer various derivatives to our customers as part of our Commercial Banking
business but usually offset our exposure through derivative transactions with other counterparties. We also enter
into interest rate and foreign exchange derivative contracts with our commercial lending customers as a customer
accommodation.
Accounting for Derivatives
Our derivatives are designated as either qualifying accounting hedges or free-standing derivatives. Free-standing
derivatives primarily consist of customer-accommodation derivatives and economic hedges that do not qualify for
hedge accounting. Qualifying accounting hedges are designated as fair value hedges, cash flow hedges or net
investment hedges.
•Fair Value Hedges: We designate derivatives as fair value hedges to manage our exposure to changes in the fair
value of certain financial assets and liabilities, which fluctuate in value as a result of movements in interest
rates. Changes in the fair value of derivatives designated as fair value hedges are recorded in earnings together
with offsetting changes in the fair value of the hedged item and any resulting ineffectiveness. Our fair value
hedges consist of interest rate swaps that are intended to modify our exposure to interest rate risk on various
fixed-rate assets and liabilities.
•Cash Flow Hedges: We designate derivatives as cash flow hedges to manage our exposure to variability in cash
flows related to forecasted transactions. Changes in the fair value of derivatives designated as cash flow hedges
are recorded as a component of AOCI, to the extent that the hedge relationships are effective, and amounts are
reclassified from AOCI to earnings as the forecasted transactions impact earnings. To the extent that any
ineffectiveness exists in the hedge relationships, the amounts are recorded in current period earnings. Our cash
flow hedges consist of interest rate swaps that are intended to hedge the variability in interest payments on
some of our variable-rate assets through 2020. These hedges have the effect of converting some of our variable-
rate assets to a fixed rate. We also have entered into forward foreign currency derivative contracts to hedge our
exposure to variability in cash flows related to foreign currency denominated intercompany borrowings.
•Net Investment Hedges: We use net investment hedges to manage the foreign currency exposure related to our
net investments in foreign operations that have functional currencies other than the U.S. dollar. Changes in the
fair value of net investment hedges are recorded in the translation adjustment component of AOCI, offsetting
the translation gain or loss from those foreign operations. During 2014, we executed net investment hedges
using foreign exchange forward contracts to hedge the translation exposure of the net investment in our foreign
operations.
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CAPITAL ONE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Capital One Financial Corporation (COF)