Estee Lauder 2007 Annual Report Download - page 52

THE EST{E LAUDER COMPANIES INC. 51
Interest Rate Risk Management
We enter into interest rate derivative contracts to manage
the exposure to fl uctuations of interest rates on our
funded and unfunded indebtedness for periods consistent
with the identifi ed exposures. All interest rate derivative
contracts are with large fi nancial institutions rated as
strong investment grade by a major rating agency.
In April 2007, we terminated an interest rate swap
agreement with a notional amount of $250.0 million to
effectively convert fi xed rate interest on the 2012 Senior
Notes to variable interest rates based on six-month LIBOR.
This instrument, which was designated as a fair-value
hedge and classifi ed as a liability, had a termination fair
value of $11.1 million at cash settlement, which included
$0.9 million of accrued interest payable to the counter-
party. Hedge accounting treatment was discontinued
prospectively and the offsetting adjustment to the carry-
ing amount of the related debt will be amortized to inter-
est expense over the remaining life of the debt.
In April 2007, in connection with the anticipated issu-
ance of debt, we entered into a series of forward-starting
interest rate swap agreements on a notional amount total-
ing $210.0 million at a weighted average all-in rate of
5.45%. These forward-starting swap agreements, desig-
nated as cash-flow hedges, were used to hedge the
exposure to a possible rise in interest rates prior to the
May 2007 issuance of debt. The agreements were settled
upon the issuance of the 2037 Senior Notes and we rec-
ognized a loss in other comprehensive income of $0.9
million that will be amortized to interest expense over the
30-year life of the 2037 Senior Notes.
In April 2007, we entered into interest rate swap agree-
ments with a notional amount totaling $250.0 million to
effectively convert the fi xed rate interest on our 2017
Senior Notes to variable interest rates based on six-month
LIBOR. The interest rate swaps were designated as fair-
value hedges. As of June 30, 2007, these fair-value hedges
were highly effective, in all material respects.
Market Risk
We use a value-at-risk model to assess the market risk of
our derivative fi nancial instruments. Value-at-risk repre-
sents the potential losses for an instrument or portfolio
from adverse changes in market factors for a specifi ed
time period and confi dence level. We estimate value-at-
risk across all of our derivative fi nancial instruments using
a model with historical volatilities and correlations calcu-
lated over the past 250-day period. The measured value-
at-risk, calculated as an average, for the twelve months
ended June 30, 2007 related to our foreign exchange con-
tracts and our interest rate contracts was $10.2 million
and $7.5 million, respectively. The model estimates were
industrial countries and are with large fi nancial institutions
rated as strong investment grade by a major rating agency.
We also may enter into foreign currency options to hedge
anticipated transactions where there is a high probability
that anticipated exposures will materialize. The forward
exchange contracts and foreign currency options entered
into to hedge anticipated transactions have been desig-
nated as cash-fl ow hedges. Hedge effectiveness of for-
ward exchange contracts is based on a hypothetical
derivative methodology and excludes the portion of fair
value attributable to the spot-forward difference which is
recorded in current-period earnings. Hedge effectiveness
of foreign currency option contracts is based on a dollar
offset methodology. The ineffective portion of both for-
ward exchange and foreign currency option contracts is
recorded in current-period earnings. For hedge contracts
that are no longer deemed highly effective, hedge
accounting is discontinued and gains and losses accumu-
lated in other comprehensive income are reclassifi ed to
earnings when the underlying forecasted transaction
occurs. If it is probable that the forecasted transaction will
no longer occur, then any gains or losses accumulated in
other comprehensive income are reclassifi ed to current-
period earnings. As of June 30, 2007, these cash-fl ow
hedges were highly effective, in all material respects.
As a matter of policy, we only enter into contracts with
counterparties that have at least an “A” (or equivalent)
credit rating. The counterparties to these contracts are
major fi nancial institutions. We do not have signifi cant
exposure to any one counterparty. Our exposure to credit
loss in the event of nonperformance by any of the
counterparties is limited to only the recognized, but not
realized, gains attributable to the contracts. Management
believes risk of default under these hedging contracts
is remote and in any event would not be material to
the consolidated fi nancial results. The contracts have
varying maturities through the end of June 2008. Costs
associated with entering into such contracts have not
been material to our consolidated fi nancial results. We do
not utilize derivative fi nancial instruments for trading or
speculative purposes.
At June 30, 2007, we had foreign currency contracts in
the form of forward exchange contracts in the amount of
$862.0 million. The foreign currencies included in forward
exchange contracts (notional value stated in U.S. dollars)
are principally the British pound ($148.1 million), Canadian
dollar ($140.3 million), Euro ($124.1 million), Swiss franc
($113.1 million), Australian dollar ($79.3 million), Japanese
yen ($42.6 million) and South Korean won ($33.6 million).
As of June 30, 2007, all of our previously outstanding
option contracts have matured.