Estee Lauder 2010 Annual Report Download - page 106

THE EST{E LAUDER COMPANIES INC. 105
gains or losses in accumulated other comprehensive
income (loss) are reclassified to current-period earnings.
As of June 30, 2010, these foreign currency cash-flow
hedges were highly effective in all material respects.
At June 30, 2010, we had foreign currency forward
contracts in the amount of $1,348.8 million. The foreign
currencies included in foreign currency forward contracts
(notional value stated in U.S. dollars) are principally the
Swiss franc ($257.5 million), British pound ($241.9 million),
Canadian dollar ($152.2 million), Euro ($148.0 million),
Hong Kong dollar ($97.3 million), Australian dollar ($88.3
million) and Japanese yen ($62.3 million).
Interest Rate Risk Management
We enter into interest rate derivative contracts to manage
the exposure to interest rate fluctuations on our funded
indebtedness and anticipated issuance of debt for periods
consistent with the identified exposures. We have interest
rate swap agreements, with a notional amount totaling
$250.0 million, to effectively convert the fixed rate inter-
est on our 2017 Senior Notes to variable interest rates
based on six-month LIBOR. These interest rate swap
agreements are designated as fair-value hedges of the
related long-term debt and meet the accounting criteria
that permit changes in the fair values of the interest rate
swap agreements to exactly offset changes in the fair
value of the underlying long-term debt. As of June 30,
2010, these fair-value hedges were highly effective in all
material respects.
Credit Risk
As a matter of policy, we only enter into derivative
contracts with counterparties that have at least an “A”
(or equivalent) credit rating. The counterparties to these
contracts are major financial institutions. Exposure to
credit risk in the event of nonperformance by any of the
counterparties is limited to the gross fair value of contracts
in asset positions, which totaled $57.7 million at June 30,
2010. To manage this risk, we have established strict coun-
terparty credit guidelines that are continually monitored
and reported to management. Accordingly, management
believes risk of loss under these hedging contracts
is remote.
Certain of our derivative financial instruments contain
credit-risk-related contingent features. As of June 30, 2010 ,
we were in compliance with such features and there were
no derivative financial instruments with credit-risk-related
contingent features that were in a net liability position.
For each derivative contract entered into where we look
to obtain special hedge accounting treatment, we formally
document all relationships between hedging instruments
and hedged items, as well as our risk-management objec-
tive and strategy for undertaking the hedge transaction,
the nature of the risk being hedged, how the hedging
instruments’ effectiveness in offsetting the hedged risk
will be assessed prospectively and retrospectively, and a
description of the method of measuring ineffectiveness.
This process includes linking all derivatives to specific assets
and liabilities on the balance sheet or to specific firm com-
mitments or forecasted transactions. We also formally
assess, both at the hedge’s inception and on an ongoing
basis, whether the derivatives that are used in hedging
transactions are highly effective in offsetting changes in
fair values or cash flows of hedged items. If it is deter-
mined that a derivative is not highly effective, or that it has
ceased to be a highly effective hedge, we will be required
to discontinue hedge accounting with respect to that
derivative prospectively.
Foreign Exchange Risk Management
We enter into foreign currency forward contracts to hedge
anticipated transactions, as well as receivables and
payables denominated in foreign currencies, for periods
consistent with our identified exposures. The purpose of
the hedging activities is to minimize the effect of foreign
exchange rate movements on costs and on the cash flows
that we receive from foreign subsidiaries. The majority of
foreign currency forward contracts are denominated in
currencies of major industrial countries. We may also
enter into foreign currency option contracts to hedge
anticipated transactions. The foreign currency forward
contracts entered into to hedge anticipated transactions
have been designated as foreign currency cash-flow
hedges and have varying maturities through the end of
June 2011. Hedge effectiveness of foreign currency
forward contracts is based on a hypothetical derivative
methodology and excludes the portion of fair value attrib-
utable 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 meth-
odology. The ineffective portion of both foreign currency
forward and 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 accumulated in other comprehensive
income (loss) are reclassified to earnings when the under-
lying forecasted transaction occurs. If it is probable that
the forecasted transaction will no longer occur, then any