Northrop Grumman 2010 Annual Report Download - page 95

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13. FAIR VALUE OF FINANCIAL INSTRUMENTS
Investments in Marketable Securities – The company holds a portfolio of marketable securities, primarily consisting
of equity securities that are classified as either trading or available-for-sale and can be liquidated without
restriction. These assets are recorded at fair value, substantially all of which are based upon quoted market prices
for identical instruments in active markets (Level 1 inputs). As of December 31, 2010, and 2009, respectively,
there were marketable equity securities of $68 million and $58 million included in prepaid expenses and other
current assets and $262 million and $233 million of marketable equity securities included in miscellaneous other
assets in the consolidated statements of financial position.
Derivative Financial Instruments and Hedging Activities – The company utilizes derivative financial instruments in
order to manage exposure to interest rate risk and foreign currency exchange rate risk. The company does not
use derivative financial instruments for trading or speculative purposes, nor does it use leveraged financial
instruments. Interest rate swap agreements utilize floating interest rates as an offset to the fixed-rate characteristics
of certain long-term debt instruments. Foreign currency forward contracts are used to manage foreign currency
exchange rate risk related to receipts from customers and payments to suppliers denominated in foreign
currencies.
Derivative financial instruments are recognized as assets or liabilities in the financial statements and measured at
fair value, substantially all of which are based on active or inactive markets for identical of similar instruments or
model-derived valuations whose inputs are observable (Level 2 inputs). Where model-derived valuations are
appropriate, the company utilizes the income approach to determine fair value and uses the applicable London
Interbank Offered Rate (LIBOR) swap rate as the discount rate. Changes in the fair value of derivative financial
instruments that qualify and are designated as fair value hedges are recorded in earnings from continuing
operations, while the effective portion of the changes in the fair value of derivative financial instruments that
qualify and are designated as cash flow hedges are recorded in other comprehensive income. Credit risk related to
derivative financial instruments is considered minimal and is managed by requiring high credit standards for
counterparties and through periodic settlements of positions.
For derivative financial instruments not designated as hedging instruments as well as the ineffective portion of
cash flow hedges, gains or losses resulting from changes in the fair value are reported in Other, net in the
consolidated statements of operations. Unrealized gains or losses on cash flow hedges are reclassified from other
comprehensive income to earnings from continuing operations upon the recognition of the underlying
transactions.
As of December 31, 2010, an interest rate swap with a notional value of $200 million, and foreign currency
purchase and sale forward contract agreements with notional values of $52 million and $86 million, respectively,
were designated for hedge accounting. The remaining notional values outstanding at December 31, 2010, under
foreign currency purchase and sale forward contracts of $12 million and $75 million, respectively, were not
designated for hedge accounting.
As of December 31, 2009, an interest rate swap with a notional value of $200 million, and foreign currency
purchase and sale forward contract agreements with notional values of $77 million and $151 million, respectively,
were designated as hedging instruments. The remaining notional values outstanding at December 31, 2009,
under foreign currency purchase and sale forward contracts of $19 million and $74 million, respectively, were not
designated for hedge accounting.
The derivative fair values and related unrealized gains and losses at December 31, 2010, and December 31, 2009,
were not material.
There were no material transfers of financial instruments between the three levels of fair value hierarchy during
the year ended December 31, 2010.
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NORTHROP GRUMMAN CORPORATION