Kraft 2004 Annual Report Download - page 44

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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, 2004 and 2003, the Company had net long commodity positions of
$443 million and $255 million, respectively. Unrealized gains or losses on net commodity positions were
immaterial at December 31, 2004 and 2003. 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, 2004 and 2003, 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 (in millions):
Pre-Tax Earnings Impact Fair Value Impact
At 12/31/04 Average High Low At 12/31/04 Average High Low
Instruments sensitive to:
Interest rates .............. $56 $66 $ 74 $56
Foreign currency rates ....... $20 $16 $25 $4
Commodity prices .......... 4 6 8 4
Pre-Tax Earnings Impact Fair Value Impact
At 12/31/03 Average High Low At 12/31/03 Average High Low
Instruments sensitive to:
Interest rates .............. $77 $97 $114 $77
Foreign currency rates ....... $21 $ 8 $21 $3
Commodity prices .......... 5 5 7 3
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.
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