IBM 2012 Annual Report Download - page 97

96 Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies
96
Anticipated Royalties and Cost Transactions
The company’s operations generate significant nonfunctional cur-
rency, 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 cur-
rency markets, the company selectively employs foreign exchange
forward contracts to manage its currency risk. These forward con-
tracts are accounted for as cash flow hedges. The maximum length
of time over which the company is hedging its exposure to the vari-
ability in future cash flows is four years. At December 31, 2012 and
2011, the total notional amount of forward contracts designated as
cash flow hedges of forecasted royalty and cost transactions was
$10.7 billion and $10.9 billion, respectively, with a weighted-average
remaining maturity of 0.7 years at both year-end dates.
At December 31, 2012 and December 31, 2011, in connection
with cash flow hedges of anticipated royalties and cost transactions,
the company recorded net losses of $138 million and net gains of
$88 million (before taxes), respectively, in AOCI. Within these
amounts $79 million of losses and $191 million of gains, respectively,
are expected to be reclassified to net income within the next 12
months, providing an offsetting economic impact against the under-
lying anticipated transactions.
Foreign Currency Denominated Borrowings
The company is exposed to exchange rate volatility on foreign cur-
rency denominated debt. To manage this risk, the company employs
cross-currency swaps to convert fixed-rate foreign currency denom-
inated 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
hedges its exposure to the variability in future cash flows is approxi-
mately three years. At December 31, 2012 and December 31, 2011,
no instruments relating to this program were outstanding.
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 com-
pany 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
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 expense in the Consolidated State-
ment of Earnings. At December 31, 2012 and 2011, the total notional
amount of derivative instruments in economic hedges of foreign
currency exposure was $12.9 billion and $13.6 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. 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, 2012 and 2011, the total notional amount of deriva-
tive instruments in economic hedges of these compensation
obligations was $1.2 billion and $1.0 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, 2012 and 2011.
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 out-
standing at December 31, 2012 and 2011.