Estee Lauder 2013 Annual Report Download - page 137

currencies of major industrial countries. We may also
enter into foreign currency option contracts to hedge
anticipated transactions where there is a high probability
that anticipated exposures will materialize. The foreign
currency forward contracts entered into to hedge antici-
pated transactions have been designated as foreign
currency cash-flow hedges and have varying maturities
through the end of March 2015. Hedge effectiveness of
foreign currency forward contracts is based on a hypo-
thetical 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 foreign currency forward and option con-
tracts 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,
2013, these foreign currency cash-flow hedges were
highly effective in all material respects.
At June 30, 2013, we had foreign currency forward
contracts in the amount of $1,579.6 million. The foreign
currencies included in foreign currency forward contracts
(notional value stated in U.S. dollars) are principally the
British pound ($426.2 million), Euro ($268.8 million),
Canadian dollar ($198.6 million), Swiss franc ($111.5 mil-
lion), Australian dollar ($92.1 million), Thailand baht
($75.5 million) and Hong Kong dollar ($58.1 million).
Credit Risk
As a matter of policy, we only enter into derivative con-
tracts with counterparties that have a long-term credit rat-
ing of at least A- or higher by at least two nationally
recognized rating agencies. 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 $21.7 million at
June 30, 2013. To manage this risk, we have established
counterparty credit guidelines that are continually moni-
tored. Accordingly, management believes risk of loss
under these hedging contracts is remote.
Certain of our derivative financial instruments contain
credit-risk-related contingent features. At June 30, 2013,
we were in a net asset position for certain derivative
contracts that contain such features with two counter-
parties. The fair value of those contracts as of June 30,
2013 was approximately $4.6 million. As of June 30, 2013,
we were in compliance 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 2013 related
to our foreign exchange contracts is as follows:
YEAR ENDED JUNE 30, 2013
(In millions) High Low Average
Foreign exchange
contracts $24.5 $19.1 $21.9
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 instruments 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. We
believe, however, that any such loss incurred would be
offset by the effects of market rate movements on the
respective underlying transactions for which the deriva-
tive financial instrument was intended.
OFF-BALANCE SHEET ARRANGEMENTS
We do not maintain any off-balance sheet arrangements,
transactions, obligations or other relationships with
unconsolidated entities, other than operating leases,
that would be expected to have a material current or
future effect upon our financial condition or results
of operations.
THE EST{E LAUDER COMPANIES INC. 135