Goldman Sachs 2007 Annual Report Download - page 106

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Notes to Consolidated Financial Statements
shifts of the relevant yield curve. Parallel shifts change the
interest rate of all maturities by identical amounts. Slope shifts
change the curvature of the yield curve. For both the prospective
assessment, in response to each of the simulated yield curve
shifts, and the retrospective assessment, a hedging relationship
is deemed to be effective if the fair value of the hedging instrument
and the hedged item change inversely within a range of 80%
to 125%.
For fair value hedges, gains or losses on derivative transactions
are recognized in “Interest expense” in the consolidated
statements of earnings. The change in fair value of the hedged
item attributable to the risk being hedged is reported as an
adjustment to its carrying value and is subsequently amortized
into interest expense over its remaining life. Gains or losses
related to hedge ineffectiveness for all hedges are generally
included in “Interest expense.” These gains or losses and the
component of gains or losses on derivative transactions
excluded from the assessment of hedge effectiveness (e.g., the
effect of the passage of time on fair value hedges of the firm’s
borrowings) were not material to the firm’s results of operations
for the years ended November 2007, November 2006 and
November 2005. Gains and losses on derivatives used for trading
purposes are included in “Trading and principal investments”
in the consolidated statements of earnings.
The firm also has embedded derivatives that have been bifurcated
from related borrowings under SFAS No. 133. Such derivatives,
which are classified in unsecured short-term and unsecured
long-term borrowings, had a carrying value of $463 million
and $1.13 billion (excluding the debt host contract) as of
November 2007 and November 2006, respectively. See Notes 4
and 5 for further information regarding the firm’s unsecured
borrowings.
The firm applies hedge accounting under SFAS No. 133 to
certain derivative contracts. The firm uses these derivatives to
manage certain interest rate and currency exposures, including
the firm’s net investment in non-U.S. operations. The firm
designates certain interest rate swap contracts as fair value
hedges. These interest rate swap contracts hedge changes in the
relevant benchmark interest rate (e.g., London Interbank
Offered Rate (LIBOR)), effectively converting a substantial
portion of the firm’s unsecured long-term and certain unsecured
short-term borrowings into floating rate obligations. See Note 2
for information regarding the firm’s accounting policy for foreign
currency forward contracts used to hedge its net investment in
non-U.S. operations.
The firm applies a long-haul method to substantially all of
its hedge accounting relationships to perform an ongoing
assessment of the effectiveness of these relationships in achieving
offsetting changes in fair value or offsetting cash flows attributable
to the risk being hedged. The firm utilizes a dollar-offset method,
which compares the change in the fair value of the hedging
instrument to the change in the fair value of the hedged item,
excluding the effect of the passage of time, to prospectively and
retrospectively assess hedge effectiveness. The firm’s prospective
dollar-offset assessment utilizes scenario analyses to test hedge
effectiveness via simulations of numerous parallel and slope
The fair value of derivatives accounted for as qualifying hedges
under SFAS No. 133 consisted of $5.12 billion and $2.66 billion
in assets as of November 2007 and November 2006, respectively,
and $354 million and $551 million in liabilities as of November 2007
and November 2006, respectively.
The fair value of the firm’s derivative contracts is reflected net of cash paid or received pursuant to credit support agreements
and is reported on a net-by-counterparty basis in the firm’s consolidated statements of financial condition when management
believes a legal right of setoff exists under an enforceable netting agreement. The fair value of derivative financial instruments,
computed in accordance with the firm’s netting policy, is set forth below:
As of November
2007 2006
(in millions) Assets Liabilities Assets Liabilities
Forward settlement contracts $ 17,447 $20,799 $11,751 $14,335
Swap agreements 54,428 39,271 28,012 22,471
Option contracts 33,739 39,308 27,780 28,690
Total $105,614 $99,378 $67,543 $65,496
104 Goldman Sachs 2007 Annual Report