Discover 2014 Annual Report Download - page 166

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-152-
Net Investment Hedges
The Company is exposed to fluctuations in foreign exchange rates on investments it holds in foreign entities with a
functional currency other than the U.S. dollar. The Company uses foreign exchange forward contracts to hedge its
exposure to changes in foreign exchange rates on its net investment in Diners Club Italy. Foreign exchange forward
contracts utilized by the Company involve fixing the U.S. dollar-euro exchange rate for delivery of a specified amount
of foreign currency on a specified date. These derivatives are designated as net investment hedges, with the effective
portion of changes in the fair value of the derivatives reported in other comprehensive income as part of the cumulative
translation adjustment. The ineffective portion of the change in fair value of the derivatives, if any, is recognized directly
in earnings. Amounts are reclassified out of accumulated other comprehensive income into earnings when the hedged
net investment is either sold or substantially liquidated.
Fair Value Hedges
The Company is exposed to changes in fair value of certain of its fixed-rate debt obligations due to changes in
interest rates. The Company uses interest rate swaps to manage its exposure to changes in fair value of certain fixed-
rate senior notes, securitized debt and interest-bearing brokered deposits attributable to changes in LIBOR, a
benchmark interest rate as defined by ASC 815. These interest rate swaps qualify as fair value hedges in accordance
with ASC 815. Changes in both (i) the fair values of the derivatives and (ii) the hedged fixed-rate senior notes,
securitized debt and interest-bearing brokered deposits relating to the risk being hedged are recorded in interest
expense. The changes generally provide substantial offset to one another, with any difference, or ineffectiveness
recorded in interest expense. Any basis differences between the fair value and the carrying amount of the hedged item
at the inception of the hedging relationship are amortized to interest expense.
Derivatives Not Designated as Hedges
Interest Rate Swaps
The Company may have, from time to time, interest rate swap agreements that are not designated as hedges. As
part of its acquisition of SLC, the Company also acquired an interest rate swap related to the securitized debt assumed
in the transaction. Such agreements are not speculative and are also used to manage interest rate risk but are not
designated for hedge accounting. Changes in the fair value of these contracts are recorded in other income.
Foreign Exchange Forward Contracts
The Company has foreign exchange forward contracts that are economic hedges and are not designated as
accounting hedges. The Company enters into foreign exchange forward contracts to manage foreign currency risk.
Changes in the fair value of these contracts are recorded in other income.
Forward Delivery Contracts
The Company economically hedges the changes in fair value of IRLCs and mortgage loans held for sale caused
by changes in interest rates by using TBA MBS and entering into best efforts forward delivery commitments. These
derivative instruments are recorded at fair value with changes in fair value recorded in other income.
Interest Rate Lock Commitments
The Company enters into commitments with consumers to originate residential mortgage loans at a specified
interest rate. The Company reports IRLCs that relate to the origination of mortgage loans that will be held for sale as
derivative instruments at fair value with changes in fair value recorded in other income.