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ManagementDiscussion
INTERNATIONALBUSINESSMACHINESCORPORATION ANDSUBSIDIARYCOMPANIES
42_ ManagementDiscussion
amount of the restructuring charges could be materially
impacted.Seenote R,“2005Actions” onpages 80 and 81 fora
descriptionofrestructuringactions.
CurrencyRateFluctuations
Changesintherelativevaluesofnon-U.S.currenciestotheU.S.
dollaraffectthecompany’sresults.AtDecember31,2005,cur-
rencychangesresultedinassetsandliabilitiesdenominatedin
localcurrenciesbeingtranslatedinto fewer dollarsthanatyear-
end 2004. The company uses a variety of financial hedging
instruments to limit specific currency risks related to financing
transactions and other foreign currency-based transactions.
Furtherdiscussionofcurrencyandhedgingappearsin note L,
“DerivativesandHedgingTransactions,” onpages 71 to 74.
The company earned approximately 45 percent of its net
incomeincurrenciesotherthantheU.S.dollar. Thecompanyalso
maintains hedging programs to limit the volatility of currency
impactsonthecompany’s financial results.Thesehedgingpro-
grams limit the impact of currency changes on the company’s
financialresultsbutdonoteliminatethem.Inadditiontothetrans-
lation of earnings and the company’s hedging programs, the
impactofcurrencychangesalsomayaffectthecompany’spric-
ingandsourcingactions.Forexample,thecompanymayprocure
components and supplies in multiple functional currencies and
sell products and services in other currencies. Therefore, it is
impracticaltoquantifytheimpact of currencyonthesetransac-
tions and on consolidated net income. Generally, the company
believesthatextendedperiodsofdollarweaknessarepositivefor
netincomeandextendedperiodsofdollarstrengtharenegative,
althoughthepreciseimpactisdifficulttoassess.
Fornon-U.S.subsidiariesandbranchesthatoperateinU.S.
dollars or whose economic environment is highly inflationary,
translation adjustments are reflected in results of operations,
as required by SFAS No. 52, “Foreign Currency Translation.”
Generally,thecompanymanagescurrencyriskintheseentities
bylinkingpricesandcontractstoU.S.dollarsandbyentering
intoforeigncurrencyhedgecontracts.
MarketRisk
In the normal course of business, the financial position of the
companyisroutinelysubjecttoavarietyofrisks.Inadditionto
themarketriskassociatedwithinterestrateandcurrencymove-
ments on outstanding debt and non-U.S. dollar denominated
assetsandliabilities,otherexamplesofriskincludecollectibility
ofaccountsreceivableandrecoverabilityofresidualvalueson
leasedassets.
Thecompanyregularlyassessestheserisksandhasestab-
lished policies and business practices to protect against the
adverse effects of these and other potential exposures. As a
result,thecompanydoesnotanticipateanymateriallossesfrom
theserisks.
The company’s debt in support of the Global Financing
businessandthegeographicbreadthofthecompany’sopera-
tionscontain anelementofmarketriskfromchangesininterest
and currency rates. The company manages this risk, in part,
through the use of a variety of financial instruments including
derivatives, as explained in note L, “Derivatives and Hedging
Transactions,” onpages 71 to74.
Tomeetdisclosurerequirements,thecompanyperformsa
sensitivity analysis to determine the effects that market risk
exposuresmayhaveon the fairvaluesof the company’s debt
andotherfinancialinstruments.
Thefinancialinstrumentsthatareincludedinthesensitivity
analysiscompriseallofthecompany’scashandcashequiva-
lents, marketable securities, long-term non-lease receivables,
investments, long-term and short-term debt and all derivative
financial instruments. The company’s portfolio of derivative
financialinstrumentsgenerallyincludesinterestrateswaps,for-
eigncurrencyswaps,forwardcontractsandoptioncontracts.
Toperformthesensitivity analysis, thecompanyassesses
the risk of loss in fair values from the effect of hypothetical
changesininterestratesandforeigncurrencyexchangerates
onmarket-sensitiveinstruments.Themarketvaluesforinterest
andforeigncurrencyexchangeriskarecomputedbasedonthe
presentvalueoffuturecashflowsasaffectedbythechangesin
rates that are attributable to the market risk being measured.
The discount rates used for the present value computations
were selected based on market interest and foreign currency
exchangerates ineffectatDecember31,2005 and2004.The
differences in this comparison are the hypothetical gains or
lossesassociatedwitheachtypeofrisk.
Information provided by the sensitivity analysis does not
necessarilyrepresenttheactual changes in fair value thatthe
companywouldincurundernormalmarketconditionsbecause,
duetopracticallimitations,allvariablesotherthanthespecific
marketriskfactorareheldconstant.Inaddition,theresultsofthe
modelareconstrainedbythefactthatcertainitemsarespecifi-
callyexcludedfromtheanalysis,whilethefinancialinstruments
relatingtothefinancingorhedgingofthoseitemsareincluded
bydefinition.Excludeditemsincludeleasedassets,forecasted
foreigncurrencycashflowsandthecompany’snetinvestment
inforeignoperations.As aconsequence,reported changes in
the values of some of the financial instruments impacting the
resultsofthesensitivityanalysisarenotmatchedwiththeoffset-
ting changes in the values of the items that those instruments
aredesignedtofinanceorhedge.
TheresultsofthesensitivityanalysisatDecember31,2005,
andDecember31,2004,areasfollows:
INTEREST RATE RISK
At December 31, 2005, a10 percent decrease in the levels of
interestrateswithallothervariablesheldconstantwouldresult
in an increase inthefairmarketvalueofthecompany’sfinancial
instrumentsof$18 millionascomparedwithadecreaseof$172
millionatDecember31,2004.A10percentincreaseinthelev-
elsofinterestrateswithallothervariablesheldconstantwould
resultin a decreaseinthefairvalueofthecompany’sfinancial
instrumentsof$8 millionascomparedto anincreaseof $153 mil-
lionatDecember31,2004.Changesintherelativesensitivityof
thefairvalueofthecompany’sfinancialinstrumentportfoliofor
thesetheoreticalchangesinthelevelofinterestratesareprima-
rilydrivenby changes inthecompany’s debtmaturity,interest
rateprofileandamount.