IBM 2010 Annual Report Download - page 100

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies98
Anticipated Royalties and Cost Transactions
The company’s operations generate significant nonfunctional
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 company. 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 contracts to manage its currency risk. These
forward contracts are accounted for as cash flow hedges. The
maximum length of time over which the company is hedging its
exposure to the variability in future cash flows is 3.9 years. At
December 31, 2010 and 2009, the total notional amount of forward
contracts designated as cash flow hedges of forecasted royalty
and cost transactions was $11.3 billion and $18.7 billion, with a
weighted-average remaining maturity of 0.8 years and 1.3 years,
respectively.
At December 31, 2010 and 2009, in connection with cash flow
hedges of anticipated royalties and cost transactions, the company
recorded net losses of $147 million and of $718 million (before
taxes), respectively, in accumulated other comprehensive income/
(loss). Within these amounts $249 million and $427 million of
losses, respectively, are expected to be reclassified to net income
within the next 12 months, providing an offsetting economic impact
against the underlying anticipated transactions.
Foreign Currency Denominated Borrowings
The company is exposed to exchange rate volatility on foreign
currency denominated debt. To manage this risk, the company
employs cross-currency swaps to convert fixed-rate foreign
currency denominated debt to fixed-rate debt denominated in the
functional currency of the borrowing entity. These swaps are
accounted for as cash flow hedges. The maximum length of time
over which the company is hedging its exposure to the variability
in future cash flows is approximately three years. At December 31,
2010 and 2009, the total notional amount of cross-currency swaps
designated as cash flow hedges of foreign currency denominated
debt was $0.2 billion and $0.3 billion, respectively.
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
economically hedge, on a net basis, the foreign currency exposure
of a portion of the company’s nonfunctional currency assets
and liabilities. The terms of these forward and swap contracts are
generally less than two years. 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
expense in the Consolidated Statement of Earnings. At December
31, 2010 and 2009, the total notional amount of derivative
instruments in economic hedges of foreign currency exposure was
$13.0 billion and $13.1 billion, respectively.
Equity Risk Management
The company is exposed to market price changes in certain broad
market indices and in the company’s own stock primarily related
to certain obligations to employees. These exposures are primarily
related to market price movements in certain broad market indices
and in the company’s own stock. Changes in the overall value of
these employee compensation obligations are recorded in SG&A
expense in the Consolidated Statement of Earnings. Although not
designated as accounting hedges, the company utilizes derivatives,
including equity swaps and futures, to economically hedge the
exposures related to its employee compensation obligations. The
derivatives are linked to the total return on certain broad market
indices or the total return on the company’s common stock. They
are recorded at fair value with gains or losses also reported
in SG&A expense in the Consolidated Statement of Earnings.
At December 31, 2010 and 2009, the total notional amount of
derivative instruments in economic hedges of these compensation
obligations was $1.0 billion and $0.8 billion, respectively.
Other Risks
The company may hold warrants to purchase shares of common
stock in connection with various investments that are deemed
derivatives because they contain net share or net cash settlement
provisions. The company records the changes in the fair value of
these warrants in other (income) and expense in the Consolidated
Statement of Earnings. The company did not have any warrants
qualifying as derivatives outstanding at December 31, 2010
and 2009.
The company is exposed to a potential loss if a client fails to
pay amounts due under contractual terms. The company utilizes
credit default swaps to economically hedge its credit exposures.
These derivatives have terms of one year or less. The swaps are
recorded at fair value with gains and losses reported in other
(income) and expense in the Consolidated Statement of Earnings.
The company did not have any derivative instruments relating to
this program outstanding at December 31, 2010 and 2009.