Kraft 2003 Annual Report Download - page 39

Commodities: The Company is exposed to price risk related to
forecasted purchases of certain commodities used as raw materials
by the Company’s businesses. Accordingly, the Company uses
commodity forward contracts as cash flow hedges, primarily for
coffee, cocoa, milk and cheese. Commodity futures and options
are also used to hedge the price of certain commodities, including
milk, coffee, cocoa, wheat, corn, sugar and soybean oil. In general,
commodity forward contracts qualify for the normal purchase
exception under SFAS No. 133 and are, therefore, not subject to
the provisions of SFAS No. 133. At December 31, 2003 and 2002,
the Company had net long commodity positions of $255 million
and $544 million, respectively. Unrealized gains or losses on net
commodity positions were immaterial at December 31, 2003
and 2002. The effective portion of unrealized gains and losses
on commodity futures and option contracts is deferred as a
component of accumulated other comprehensive earnings
(losses) and is recognized as a component of cost of sales in
the Company’s consolidated statement of earnings when the
related inventory is sold.
Value at Risk: The Company uses a value at risk (“VAR”)
computation to estimate the potential one-day loss in the fair value
of its interest rate-sensitive financial instruments and to estimate
the potential one-day loss in pre-tax earnings of its foreign currency
and commodity price-sensitive derivative financial instruments.
The VAR computation includes the Company’s debt; short-term
investments; foreign currency forwards, swaps and options; and
commodity futures, forwards and options. Anticipated transactions,
foreign currency trade payables and receivables, and net
investments in foreign subsidiaries, which the foregoing instruments
are intended to hedge, were excluded from the computation.
The VAR estimates were made assuming normal market
conditions, using a 95% confidence interval. The Company used
a“variance/co-variance” model to determine the observed
interrelationships between movements in interest rates and various
currencies. These interrelationships were determined by observing
interest rate and forward currency rate movements over the
preceding quarter for the calculation of VAR amounts at December
31, 2003 and 2002, and over each of the four preceding quarters
for the calculation of average VAR amounts during each year. The
values of foreign currency and commodity options do not change
on a one-to-one basis with the underlying currency or commodity,
and were valued accordingly in the VAR computation.
The estimated potential one-day loss in fair value of the Company’s
interest rate-sensitive instruments, primarily debt, under normal
market conditions and the estimated potential one-day loss in
pre-tax earnings from foreign currency and commodity instruments
under normal market conditions, as calculated in the VAR model,
were as follows:
Pre-Tax Earnings Impact
(in millions) At 12/31/03 Average High Low
Instruments sensitive to:
Foreign currency rates $21 $ 8 $21 $3
Commodity prices 55 73
Fair Value Impact
(in millions) At 12/31/03 Average High Low
Instruments sensitive to:
Interest rates $77 $97 $114 $77
Pre-Tax Earnings Impact
(in millions) At 12/31/02 Average High Low
Instruments sensitive to:
Foreign currency rates $5 $2 $ 5 $1
Commodity prices 46 94
Fair Value Impact
(in millions) At 12/31/02 Average High Low
Instruments sensitive to:
Interest rates $76 $74 $ 76 $70
This VAR computation is a risk analysis tool designed to statistically
estimate the maximum probable daily loss from adverse movements
in interest rates, foreign currency rates and commodity prices under
normal market conditions. The computation does not purport to
represent actual losses in fair value or earnings to be incurred by the
Company, nor does it consider the effect of favorable changes in
market rates. The Company cannot predict actual future movements
in such market rates and does not present these VAR results to
be indicative of future movements in such market rates or to be
representative of any actual impact that future changes in market
rates may have on its future results of operations or financial position.
New Accounting Standards
See Note 2 to the consolidated financial statements for a discussion
of recently adopted accounting standards.
Contingencies
See Note 17 to the consolidated financial statements for a discussion
of contingencies.
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