HP 2005 Annual Report Download - page 69

ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk.
In the normal course of business, we are exposed to foreign currency exchange rate, interest rate
and equity price risks that could impact our financial position and results of operations. Our risk
management strategy with respect to these three market risks may include the use of derivative
financial instruments. We use derivative contracts only to manage existing underlying exposures of HP.
Accordingly, we do not use derivative contracts for speculative purposes. Our risks, risk management
strategy and a sensitivity analysis estimating the effects of changes in fair values for each of these
exposures are outlined below.
Actual gains and losses in the future may differ materially from the sensitivity analyses based on
changes in the timing and amount of interest rate, foreign currency exchange rate and equity price
movements and our actual exposures and hedges.
Foreign currency exchange rate risk
We are exposed to foreign currency exchange rate risk inherent in our sales commitments,
anticipated sales, anticipated purchases and assets, liabilities and debt denominated in currencies other
than the U.S. dollar. We transact business in approximately 40 currencies worldwide, of which the most
significant to our operations for fiscal 2005 were the euro, the Japanese yen and the British pound. For
most currencies, we are a net receiver of the foreign currency and therefore benefit from a weaker U.S.
dollar and are adversely affected by a stronger U.S. dollar relative to the foreign currency. Even where
HP is a net receiver, a weaker U.S. dollar may adversely affect certain expense figures taken alone. We
use a combination of forward contracts and options designated as cash flow hedges to protect against
the foreign currency exchange rate risks inherent in our forecasted net revenue and, to a lesser extent,
cost of sales denominated in currencies other than the U.S. dollar. In addition, when debt is
denominated in a foreign currency, HP may use swaps to exchange the foreign currency principal and
interest obligations for U.S. dollar-denominated amounts to manage the exposure to changes in foreign
currency exchange rates. HP also uses other derivatives not designated as hedging instruments under
SFAS No. 133, ‘‘Accounting for Derivative Instruments and Hedging Activities,’’ consisting primarily of
forward contracts to hedge foreign currency balance sheet exposures. HP recognizes the gains and
losses on foreign currency forward contracts in the same period as the remeasurement losses and gains
of the related foreign currency-denominated exposures. Alternatively, HP may choose not to hedge the
foreign currency risk associated with its foreign currency exposures if such exposure acts as a natural
foreign currency hedge for other offsetting amounts denominated in the same currency.
We have performed sensitivity analyses as of October 31, 2005 and 2004, using a modeling
technique that measures the change in the fair values arising from a hypothetical 10% adverse
movement in the levels of foreign currency exchange rates relative to the U.S. dollar, with all other
variables held constant. The analyses cover all of our foreign currency contracts offset by the underlying
exposures. The foreign currency exchange rates we used were based on market rates in effect at
October 31, 2005 and 2004. The sensitivity analyses indicated that a hypothetical 10% adverse
movement in foreign currency exchange rates would result in a foreign exchange loss of $90 million at
October 31, 2005 and $71 million at October 31, 2004.
Interest rate risk
We also are exposed to interest rate risk related to our debt and investment portfolios and
financing receivables. HP issues long-term debt in either U.S. dollars or foreign currencies based on
market conditions at the time of financing. HP then typically uses interest rate swaps to modify the
market risk exposures in connection with the debt to achieve primarily U.S. dollar LIBOR-based
floating interest expense and to manage exposure to foreign currency exchange rates. The swap
transactions generally involve the exchange of fixed for floating interest payments. However, HP may
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