Prudential 2002 Annual Report Download - page 99
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Please find page 99 of the 2002 Prudential annual report below. You can navigate through the pages in the report by either clicking on the pages listed below, or by using the keyword search tool below to find specific information within the annual report.PRUDENTIAL FINANCIAL, INC.
Notes to Consolidated Financial Statements
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Derivatives are financial instruments whose values are derived from interest rates, foreign exchange rates,
financial indices, or the value of securities or commodities. Derivative financial instruments used by the Company
include swaps, futures, forwards and option contracts and may be exchange-traded or contracted in the over-the-
counter market. Derivative positions are carried at estimated fair value, generally by obtaining quoted market
prices or through the use of pricing models. Values can be affected by changes in interest rates, foreign exchange
rates, financial indices, value of securities or commodities, credit spreads, market volatility and liquidity. Values
can also be affected by changes in estimates and assumptions used in pricing models.
Derivatives are used to manage the characteristics of the Company’s asset/liability mix, manage the interest
rate and currency characteristics of invested assets and to mitigate the risk of a diminution, upon translation to
U.S. dollars, of expected non-U.S. earnings resulting from unfavorable changes in currency exchange rates. They
are also used in a derivative dealer capacity in the Company’s securities operations to meet the needs of clients by
structuring transactions that allow clients to manage their exposure to interest rates, foreign exchange rates,
indices or prices of securities and commodities and similarly in a dealer capacity through the operation of hedge
portfolios in a limited-purpose subsidiary. Additionally, derivatives may be used to seek to reduce exposure to
interest rate and foreign currency risks associated with assets held or expected to be purchased or sold, and
liabilities incurred or expected to be incurred.
Derivatives are recorded in the Consolidated Statements of Financial Position either as assets, within
“Trading account assets” or “Broker-dealer related receivables,” or as liabilities within “Broker-dealer related
payables” or “Other liabilities.” Realized and unrealized changes in fair value of derivatives used in a dealer
capacity are included in “Commissions and other income” in the Consolidated Statements of Operations in the
periods in which the changes occur. Cash flows from such derivatives are reported in the operating activities
section of the Consolidated Statements of Cash Flows.
As discussed in detail below and in Note 20, all realized and unrealized changes in fair value of non-dealer
related derivatives, with the exception of the effective unrealized portion of cash flow hedges and effective hedges
of net investment in foreign operations, are recorded in current earnings. Cash flows from these derivatives are
reported in the investing activities section in the Consolidated Statements of Cash Flows.
For non-dealer related derivatives the Company designates derivatives as either (1) a hedge of the fair value
of a recognized asset or liability or unrecognized firm commitment (“fair value” hedge); (2) a hedge of a
forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or
liability (“cash flow” hedge); (3) a foreign-currency fair value or cash flow hedge (“foreign currency” hedge); (4)
a hedge of a net investment in a foreign operation; or (5) a derivative that does not qualify for hedge accounting.
To qualify for hedge accounting treatment, a derivative must be highly effective in mitigating the designated
risk of the hedged item. Effectiveness of the hedge is formally assessed at inception and throughout the life of the
hedging relationship. Even if a derivative qualifies for hedge accounting treatment, there may be an element of
ineffectiveness of the hedge. Under such circumstances, the ineffective portion of adjusting the derivative to fair
value is recorded in “Realized investment gains (losses), net.”
The Company formally documents all relationships between hedging instruments and hedged items, as well
as its risk-management objective and strategy for undertaking various hedge transactions. This process includes
linking all derivatives designated as fair value, cash flow or foreign currency hedges to specific assets and
liabilities on the balance sheet or to specific firm commitments or forecasted transactions.
When a derivative is designated as a fair value hedge and is determined to be highly effective, changes in its
fair value, along with changes in the fair value of the hedged asset or liability (including losses or gains on firm
commitments), are reported on a net basis in the income statement line item associated with the hedged item.
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