Cisco 2007 Annual Report Download - page 40

2007 Annual Report 43
Quantitative and Qualitative Disclosures About Market Risk
Long-Term Debt
At any time, a sharp fall in interest rates could have a material adverse impact on the fair value of $6.0 billion of our fixed-rate debt. Conversely,
a sharp rise in interest rates could have a material favorable impact. We have entered into $6.0 billion notional amount of interest rate swaps
designated as fair value hedges, and gains and losses in the fair value of these swaps offset changes in the fair value of the fixed-rate debt.
In effect, these swaps convert the fixed interest rates to floating interest rates based on LIBOR. A sharp change in rates would not have a
material impact on the fair value of our $500 million variable-rate debt.
A sharp rise in short-term interest rates could have a material adverse impact on interest expense, while a sharp fall in short-term rates
could have a material favorable impact. To mitigate these impacts, we presently invest a portion of our interest-bearing assets in instruments
with similar interest rate characteristics as the swapped debt.
Derivative Instruments
Foreign Currency Derivatives
We enter into foreign exchange forward contracts to reduce the short-term effects of foreign currency fluctuations on receivables, investments,
and payables, primarily denominated in Australian, Canadian, Japanese, and several European currencies, including the euro and British
pound. Our market risks associated with our foreign currency receivables, investments, and payables relate primarily to variances from our
forecasted foreign currency transactions and balances.
The impact of foreign currency fluctuations on sales has not been material because our sales are primarily denominated in U.S. dollars.
Approximately 75% of our operating expenses are U.S.-dollar denominated. To reduce variability in operating expenses caused by the
remaining non-U.S.-dollar denominated operating expenses, we hedge certain foreign currency forecasted transactions with currency
options and forward contracts with maturities up to 18 months. These hedging programs are not designed to provide foreign currency
protection over longer time horizons. In designing a specific hedging approach, we consider several factors, including offsetting exposures,
significance of exposures, costs associated with entering into a particular hedge instrument, and potential effectiveness of the hedge.
The gains and losses on foreign exchange contracts mitigate the variability in operating expenses associated with currency movements.
Primarily because of our limited currency exposure to date, the effect of foreign currency fluctuations has not been material to our
Consolidated Financial Statements. The effect of foreign currency fluctuations, net of hedging, on the increase in total research and
development, sales and marketing, and general and administrative expenses was not material in fiscal 2007.
Foreign exchange forward and option contracts as of July 28, 2007 and July 29, 2006 are summarized as follows (in millions):
July 28, 2007 July 29, 2006
Notional
Amount Fair Value
Notional
Amount Fair Value
Forward contracts:
Purchased $ 1,601 $ 1 $ 1,376 $ (2)
Sold $ 613 $ (8) $ 554 $ (3)
Option contracts:
Purchased $ 652 $ 24 $ 591 $ 20
Sold $ 310 $ (1) $ 573 $ (2)
Our foreign exchange forward contracts related to current assets and liabilities generally range from one to three months in original
maturity. Additionally, we have entered into foreign exchange forward contracts related to long-term customer financings with maturities
of up to two years. The foreign exchange forward contracts related to investments generally have maturities of less than 18 months. We
do not enter into foreign exchange forward or option contracts for trading purposes. We do not expect gains or losses on these derivative
instruments to have a material impact on our financial results. See Note 8 to the Consolidated Financial Statements.