IBM 2005 Annual Report Download - page 73
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Please find page 73 of the 2005 IBM annual report below. You can navigate through the pages in the report by either clicking on the pages listed below, or by using the keyword search tool below to find specific information within the annual report.NotestoConsolidatedFinancialStatements
INTERNATIONALBUSINESSMACHINESCORPORATION ANDSUBSIDIARYCOMPANIES
72_ NotestoConsolidatedFinancialStatements
thecompanytonetamountsduefromthecompanytoacoun-
terpartywithamountsduetothecompanyfromacounterparty
reducingthemaximumlossfromcreditriskintheeventofcoun-
terpartydefault.
In its hedging programs, the company uses forward con-
tracts, futures contracts, interest-rate swaps, currency swaps,
and options depending upon the underlying exposure. The
company does not use derivatives for trading or speculative
purposes,norisitapartytoleveragedderivatives.
Abriefdescriptionofthemajorhedgingprogramsfollows.
DebtRiskManagement
Thecompanyissuesdebtintheglobalcapitalmarkets,princi-
pally to fund its financing lease and loan portfolio. Access to
cost-effective financing can result in interest rate and/or cur-
rencymismatcheswiththeunderlyingassets.Tomanagethese
mismatches and to reduce overall interest cost, the company
uses interest-rate swaps to convert specific fixed-rate debt
issuancesintovariable-ratedebt(i.e.,fairvaluehedges)andto
convert specific variable-rate debt issuances into fixed-rate
debt(i.e.,cashflowhedges).Theresultingcostoffundsislower
thanthatwhichwouldhavebeenavailableifdebtwithmatching
characteristicswasissueddirectly.AtDecember 31,2005,the
weighted-average remaining maturity of all swaps in the debt
riskmanagementprogramwasapproximatelyfouryears.
Long-TermInvestmentsinForeign
Subsidiaries(NetInvestment)
Asignificantportionofthecompany’sforeigncurrencydenomi-
nateddebtportfolioisdesignatedasahedgeofnetinvestment
to reduce the volatility in stockholders’ equity caused by
changes in foreign currency exchange rates in the functional
currencyof major foreignsubsidiaries with respect to the U.S.
dollar. The company also uses currency swaps and foreign
exchangeforwardcontractsforthisriskmanagementpurpose.
Thecurrencyeffectsofthesehedges(approximately$570mil-
liongainsin2005,$156millionlossesin2004,and$200million
lossesin2003,netoftax)werereflectedintheAccumulated
gains and (losses) not affecting retained earnings section of
the Consolidated Statement of Stockholders’ Equity, thereby
offsettingaportionofthetranslationadjustmentoftheapplica-
bleforeignsubsidiaries’netassets.
AnticipatedRoyaltiesandCostTransactions
The company’s operations generate significant nonfunctional
currency, third-party vendor payments and intercompany
paymentsforroyaltiesandgoodsandservicesamongthecom-
pany’snon-U.S.subsidiariesandwiththeparentcompany.In
anticipationoftheseforeigncurrencycashflowsandinviewof
thevolatilityofthecurrencymarkets,thecompanyselectively
employs foreign exchange forward and option contracts to
manageitscurrencyrisk. In general, these cashflow hedges
havematuritiesofoneyearorless,butfromtimetotimeextend
beyond one year commensurate with the underlying hedged
anticipatedcashflows.Themaximumlengthoftimeoverwhich
thecompanyishedgingitsexposuretothevariabilityinfuture
cashflowsistwoyears. At December 31, 2005,theweighted
averageremainingmaturityofthesederivativeinstrumentswas
240days.
SubsidiaryCashandForeign Currency
Asset/LiabilityManagement
The company uses its Global Treasury Centers to manage the
cashofitssubsidiaries.Thesecentersprincipallyusecurrency
swapstoconvertcashflowsinacost-effectivemanner.Inaddi-
tion, the company uses foreign exchange forward contracts to
economicallyhedge,onanetbasis,theforeigncurrencyexpo-
sureofaportionofthecompany’snonfunctionalcurrencyassets
andliabilities.Thetermsoftheseforwardandswapcontractsare
generally less than one year. The changes in the fair values of
these contracts and of the underlying hedged exposures are
generally offsetting and are recorded in Other (income) and
expenseintheConsolidatedStatementofEarnings.
EquityRisk Management
Thecompanyisexposedtoequitypricechangesrelatedtocer-
tainobligationstoemployees.Theseequityexposuresarepri-
marilyrelatedtomarketpricemovementsincertainbroadequity
marketindicesandinthecompany’sownstock.Changesinthe
overall value of these employee compensation obligations are
recorded in SG&A expense in the Consolidated Statement of
Earnings.Althoughnotdesignatedasaccountinghedges, the
companyutilizesequityderivatives,includingequityswapsand
futures, to economically hedge the exposures related to its
employeecompensationobligations.Thederivativesarelinked
tothetotalreturnoncertainbroadequitymarketindicesorthe
totalreturnonthecompany’scommonstock.Theyarerecorded
atfairvaluewithgainsorlossesalsoreportedinSG&Aexpense
intheConsolidatedStatementofEarnings.
OtherDerivatives
Thecompanyholdswarrantsinconnectionwithcertaininvest-
ments that are deemed derivatives because they contain net
shareornetcashsettlementprovisions.Thecompanyrecords
thechangesinthefairvalueofthesewarrantsinOther(income)
andexpenseintheConsolidatedStatementofEarnings.
Thecompanyisexposedtoapotentiallossifa client failsto
payamountsdueundercontractualterms(“creditrisk”).In2003,
thecompany began utilizingcreditdefaultswapsto economi-
cally hedge certain credit exposures. These derivatives have
termsofthreeyearsorless.Theswapsarerecordedatfairvalue
with gains and losses reported in SG&A expense in the
ConsolidatedStatementofEarnings.
To economically hedge its foreign exchange exposure
notcoveredbyanyofthe aboveprograms,thecompanyalso
uses certain forward and option contracts that are not desig-
nated in accounting hedging relationships. These derivatives
arerecordedatfairvaluewithgainsandlossesreportedinOther
(income)andexpenseintheConsolidatedStatementofEarnings.