Estee Lauder 2011 Annual Report Download - page 116

114 THE EST{E LAUDER COMPANIES INC.
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
March 2013. Hedge effectiveness of foreign currency for-
ward contracts is based on a hypothetical derivative meth-
odology 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 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 underlying forecasted transaction occurs. If it is
probable that the forecasted transaction will no longer
occur, then any gains or losses in accumulated other
comprehensive income (loss) are reclassified to current-
period earnings. As of June 30, 2011, these foreign
currency cash-flow hedges were highly effective in all
material respects.
At June 30, 2011, the Company had foreign currency
forward contracts in the amount of $1,490.7 million. The
foreign currencies included in foreign currency forward
contracts (notional value stated in U.S. dollars) are princi-
pally the Swiss franc ($284.9 million), British pound
($273.5 million), Canadian dollar ($210.1 million), Euro
($164.6 million), Australian dollar ($110.7 million), Korean
won ($77.9 million) and Russian ruble ($45.2 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. During fiscal
2011, we terminated our interest rate swap agreements
with a notional amount totaling $250.0 million which had
effectively converted the fixed rate interest on our out-
standing 2017 Senior Notes to variable interest rates. The
instrument, which was classified as an asset, had a fair
value of $47.4 million at the date of cash settlement.
Hedge accounting treatment was discontinued prospec-
tively and the fair value adjustment to the carrying
amount of the related debt is being amortized against
interest expense over the remaining life of the debt.
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 con-
tracts in asset positions, which totaled $15.0 million at
June 30, 2011. To manage this risk, we have established
counterparty 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,
2011, we were in a net liability position for certain deriva-
tive contracts that contain such features with two counter-
parties. The fair value of those contracts as of June 30,
2011 was approximately $3.4 million and we were in com-
pliance with such credit-risk-related contingent features.
Market Risk
We use a value-at-risk model to assess the market risk of
our derivative financial instruments. Value-at-risk repre-
sents the potential losses for an instrument or portfolio
from adverse changes in market factors for a specified
time period and confidence level. We estimate value-at-
risk across all of our derivative financial instruments using
a model with historical volatilities and correlations calcu-
lated over the past 250-day period. The high, low and
average measured value-at-risk during fiscal 2011 related
to our foreign exchange contracts is as follows:
JUNE 30, 2011
(In millions) High Low Average
Foreign exchange
contracts $31.7 $19.8 $24.9
The model estimates were made assuming normal market
conditions and a 95 percent confidence level. We used a
statistical simulation model that valued our derivative
financial instruments against one thousand randomly gen-
erated market price paths.
Our calculated value-at-risk exposure represents an
estimate of reasonably possible net losses that would be
recognized on our portfolio of derivative financial instru-
ments assuming hypothetical movements in future market
rates and is not necessarily indicative of actual results,
which may or may not occur. It does not represent the
maximum possible loss or any expected loss that may
occur, since actual future gains and losses will differ from
those estimated, based upon actual fluctuations in market
rates, operating exposures, and the timing thereof, and
changes in our portfolio of derivative financial instruments
during the year.