IBM 2010 Annual Report Download - page 99

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies 97
arrangements. The aggregate fair value of derivative instruments
in net asset positions as of December 31, 2010 and 2009 was
$1,099 million and $838 million, respectively. This amount repre-
sents the maximum exposure to loss at the reporting date as a
result of the counterparties failing to perform as contracted. This
exposure was reduced by $475 million and $573 million at
December 31, 2010 and 2009, respectively, of liabilities included
in master netting arrangements with those counterparties.
Additionally, at December 31, 2010, this exposure was reduced by
$88 million of collateral received by the company.
The company does not offset derivative assets against liabili-
ties in master netting arrangements nor does it offset receivables
or payables recognized upon payment or receipt of cash collateral
against the fair values of the related derivative instruments. At
December 31, 2010, $9 million was recognized in other receivables
for the right to reclaim cash collateral. At December 31, 2009, $37
million was recorded in prepaid expenses and other current assets
for the right to reclaim cash collateral. The amount recognized in
accounts payable for the obligation to return cash collateral totaled
$88 million at December 31, 2010. The company had no obligation
to return cash collateral at December 31, 2009. The company
restricts the use of cash collateral received to rehypothecation,
and therefore reports it in prepaid expenses and other current
assets in the Consolidated Statement of Financial Position. At
December 31, 2010, $9 million was rehypothecated.
The company may employ derivative instruments to hedge the
volatility in stockholders’ equity resulting from changes in currency
exchange rates of significant foreign subsidiaries of the company
with respect to the U.S. dollar. These instruments, designated as
net investment hedges, expose the company to liquidity risk as
the derivatives have an immediate cash flow impact upon maturity
which is not offset by a cash flow from the translation of the under-
lying hedged equity. The company monitors this cash loss potential
on an ongoing basis, and may discontinue some of these hedging
relationships by de-designating the derivative instrument in order
to manage the liquidity risk. Although not designated as accounting
hedges, the company may utilize derivatives to offset the changes
in the fair value of the de-designated instruments from the date of
de-designation until maturity.
In its hedging programs, the company uses forward contracts,
futures contracts, interest-rate swaps and cross-currency swaps,
depending upon the underlying exposure. The company is not a
party to leveraged derivative instruments.
A brief description of the major hedging programs, categorized
by underlying risk, follows.
Interest Rate Risk
Fixed and Variable Rate Borrowings
The company issues debt in the global capital markets, principally
to fund its financing lease and loan portfolio. Access to cost-
effective financing can result in interest rate mismatches with the
underlying assets. To manage these mismatches and to reduce
overall interest cost, the company uses interest-rate swaps to
convert specific fixed-rate debt issuances into variable-rate debt
(i.e., fair value hedges) and to convert specific variable-rate debt
issuances into fixed-rate debt (i.e., cash flow hedges). At December
31, 2010 and 2009, the total notional amount of the company’s
interest rate swaps was $7.1 billion and $9.1 billion, respectively.
Forecasted Debt Issuance
The company is exposed to interest rate volatility on future debt
issuances. To manage this risk, the company may use forward
starting interest-rate swaps to lock in the rate on the interest
payments related to the forecasted debt issuance. These swaps
are accounted for as cash flow hedges. The company did not have
any derivative instruments relating to this program outstanding at
December 31, 2010 and 2009.
At December 31, 2010 and 2009, net losses of approximately
$15 million and $18 million (before taxes), respectively, were recorded
in accumulated other comprehensive income/(loss) in connection
with cash flow hedges of the company’s borrowings. Within these
amounts $9 million and $10 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 transactions.
Foreign Exchange Risk
Long-Term Investments in Foreign Subsidiaries
(Net Investment)
A large portion of the company’s foreign currency denominated
debt portfolio is designated as a hedge of net investment 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
cross-currency swaps and foreign exchange forward contracts
for this risk management purpose. At December 31, 2010 and
2009, the total notional amount of derivative instruments desig-
nated as net investment hedges was $1.9 billion and $1.0 billion,
respectively. The weighted-average remaining maturity of these
instruments at December 31, 2010 and 2009 was approximately
0.4 years and 1.6 years, respectively.
In addition, at December 31, 2010 and 2009, the company had
liabilities of $221 million and $318 million, respectively, representing
the fair value of derivative instruments that were previously desig-
nated in qualifying net investment hedging relationships, but were
de-designated prior to December 31, 2010 and 2009, respectively;
of these amounts $221 million and $94 million are expected to
mature over the next 12 months, respectively. The notional amount
of these instruments at December 31, 2010 and 2009 was $1.6
billion and $2.3 billion, respectively, including original and offsetting
transactions.