IBM 2001 Annual Report Download - page 88

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Notes to Consolidated Financial Statements
INTERNATIONAL BUSINESS MACHINES CORPORATION
and Subsidiary Companies
86
commercial paper issuances to fixed rates (i.e., cash flow
hedges). The resulting cost of funds is lower than that which
would have been available if debt with matching character-
istics was issued directly. The weighted-average remaining
maturity of all swaps in the debt risk management program
is approximately four years.
Long-Term Investments in Foreign Subsidiaries
(“net investments”)
A significant portion of the company’s foreign currency
denominated debt portfolio is designated as a hedge to reduce
the volatility in stockholders’ equity caused by changes in
foreign currency exchange rates in the functional currency
of major foreign subsidiaries with respect to the U.S. dollar.
The company also uses currency swaps and foreign exchange
forward contracts for this risk management purpose. The
currency effects of these hedges (approximately $506 million
for the current period, net of tax) are reflected as a credit in
the Accumulated gains and losses not affecting retained earn-
ings section of the Consolidated Statement of Stockholders’
Equity, thereby offsetting a portion of the translation of the
applicable foreign subsidiaries’ net assets.
Anticipated Royalties and Cost Transactions
The company’s operations generate significant non functional
currency third party vendor payments and intercompany
payments for royalties and goods and services among the
company’s non-U.S. subsidiaries and with the parent com-
pany. In anticipation of these foreign currency cash flows
and in view of the volatility of the currency markets, the
company selectively employs foreign exchange forward and
option contracts to manage its currency risk. At December 31,
2001, the maximum remaining maturity of these derivative
instruments was less than 24 months, commensurate with
the underlying hedged anticipated cash flows. The effective
portion of the gain or loss of these contracts is reported in
net income when the underlying transactions occur.
Classification of derivative gains and losses in the
Consolidated Statement of Earnings is consistent with the
recognition of the specific underlying transactions hedged.
Subsidiary Cash and Foreign Currency
Asset/Liability Management
The company uses its Global Treasury Centers to manage the
cash of its subsidiaries. These centers principally use currency
swaps to convert cash flows in a cost-effective manner. In
addition, the company uses foreign exchange forward contracts
to hedge, on a net basis, the foreign currency exposure of a
portion of the company’s non functional currency assets and
liabilities. The terms of these forward and swap contracts are
generally less than one year. The changes in fair value from
these contracts and from the underlying hedged exposures are
generally offsetting and are recorded in Other income and
expense in the Consolidated Statement of Earnings.
Equity Risk Management
The company is exposed to certain equity price changes
related to certain obligations to employees. These equity
exposures are primarily related to market value movements
in certain broad equity market indices and in the company’s
own stock. Changes in the overall value of this employee
compensation obligation are recorded in SG&A expense in
the Consolidated Statement of Earnings. Although not
designated as accounting hedges, the company utilizes
equity derivatives, including equity swaps and futures to eco-
nomically hedge the equity exposures relating to this
employee compensation obligation. To match the exposures
relating to this employee compensation obligation, these
derivatives are linked to the total return of certain broad
equity market indices and/or the total return of the com-
pany’s common stock. These derivatives are recorded at fair
value with gains or losses also reported in SG&A expense in
the Consolidated Statement of Earnings.
Other Derivatives
The company holds warrants in connection with certain
investments that, although not designated as hedging instru-
ments, are deemed derivatives since they contain net share
settlement clauses. During the year, the company recorded
the change in the fair value of these warrants in net income.
The following table summarizes the net fair value of the
company’s derivative and other risk management instru-
ments at December 31, 2001, included in the Consolidated
Statement of Financial Position.