HR Block 2006 Annual Report Download - page 107

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
GENERAL
INTEREST RATE RISK –We have a formal investment policy to help adjustments are recorded as a separate component of other
minimize the market risk exposure of our cash equivalents and comprehensive income in stockholders’ equity. Translation of financial
available-for-sale securities, which are primarily affected by credit results into U.S. dollars does not presently materially affect, and has not
quality and movements in interest rates. These guidelines focus on historically materially affected, our consolidated financial results,
managing liquidity and preserving principal and earnings. Most of our although such changes do affect the year-to-year comparability of the
interest rate-sensitive assets and liabilities are managed at the operating results in U.S. dollars of our international businesses. We
subsidiary level. estimate a 10% change in foreign exchange rates by itself would impact
Our cash equivalents are primarily held for liquidity purposes and are consolidated pretax income in fiscal years 2006 and 2005 by
comprised of high quality, short-term investments, including qualified approximately $2.1 million and $1.3 million, respectively, and cash
money market funds. As of April 30, 2006, our non-restricted cash and balances at April 30, 2006 and 2005 by $6.1 million and $4.7 million,
cash equivalents had an average maturity of less than three months with respectively.
an average credit quality of AAA. With such a short maturity, our
MORTGAGE SERVICES
portfolio’s market value is relatively insensitive to interest rate changes. INTEREST RATE RISK – NON-PRIME ORIGINATIONS –Interest rate
We hold investments in fixed income securities at our captive insurance changes impact the value of the loans underlying our beneficial interest
subsidiary. See the table below for sensitivities to changes in interest in Trusts, on our balance sheet or in our origination pipeline, as well as
rates. See additional discussion of interest rate risk included below in residual interests in securitizations and MSRs.
Mortgage Services and Investment Services. As a result of loan sales to the Trusts, we remove the mortgage loans
At April 30, 2006, no commercial paper was outstanding. For fiscal from our balance sheet and record the gain on sale, cash, MSRs,
year 2006, the average issuance term was 33 days and the average recourse reserves and a beneficial interest in Trusts, which represents
outstanding balance was $558.4 million. As commercial paper and bank our residual interest in the ultimate expected outcome from the
borrowings are seasonal, interest rate risk typically increases through disposition of the loans by the Trusts. See Item 7, ‘‘Off-Balance Sheet
our third fiscal quarter and declines to zero by fiscal year-end. See Financing Arrangements.’’ At April 30, 2006, there were $7.8 billion of
Item 7, ‘‘Financial Condition’’ for additional information. loans held in the Trusts and the value of our beneficial interest in Trusts
Our current portion of long-term debt and long-term debt at April 30, was $188.0 million. At April 30, 2006, we had $236.4 million of mortgage
2006 consists primarily of fixed-rate Senior Notes; therefore, a change in loans held for sale and $407.5 million of mortgage loans held for
interest rates would have no impact on consolidated pretax earnings. investment on our balance sheet. Changes in interest rates and other
See Item 8, note 9 to our consolidated financial statements. market factors may result in a change in value of our beneficial interest
EQUITY PRICE RISK –We have exposure to the equity markets in in Trusts, mortgage loans held for sale and mortgage loans held for
several ways. The largest exposure, though relatively small, is through investment.
our deferred compensation plans. Within the deferred compensation We are exposed to interest rate risk associated with commitments to
plans we have mismatches in asset and liability amounts and investment fund approved loan applications of $4.0 billion, subject to conditions
choices (both fixed-income and equity). At April 30, 2006 and 2005, the and loan contract verification. In addition, we have interest rate risk
impact of a 10% market value change in the combined equity assets held related to $1.0 billion in new loan applications which have not yet been
by our deferred compensation plans and other equity investments approved, and $3.0 billion of applications which we expect to receive
would be approximately $11.6 million and $9.3 million, respectively, prior to our next anticipated change in rates charged to borrowers. Of
assuming no offset for the liabilities. these amounts, we estimate only $5.1 billion will likely be originated.
TAX SERVICES We use forward loan sale commitments, interest rate swaps and put
FOREIGN EXCHANGE RATE RISK –Our operations in international options on Eurodollar futures to reduce our interest rate risk associated
markets are exposed to movements in currency exchange rates. The with non-prime loans. Forward loan sale commitments represent an
currencies involved are the Canadian dollar, the Australian dollar and obligation to sell a non-prime loan at a specific price in the future and
the British pound. We translate revenues and expenses related to these increase in value as rates rise and decrease as rates fall. At April 30,
operations at the average of exchange rates in effect during the period. 2006, there were $3.1 billion in forward loan sale commitments, and
Assets and liabilities of foreign subsidiaries are translated into U.S. most of them give us the option to under- or over-deliver by five to ten
dollars at exchange rates prevailing at the end of the year. Translation percent. Forward loan sale commitments lock in the execution price on
H&R BLOCK 2006 Form 10K
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