Quest Diagnostics 2009 Annual Report Download - page 83

Interest Rate Risk
The Company is exposed to interest rate risk on its cash and cash equivalents and its debt obligations.
Interest income earned on cash and cash equivalents may fluctuate as interest rates change; however, due to their
relatively short maturities, the Company does not hedge these assets and the impact of interest rate risk is not
material. The Company’s debt obligations consist of fixed-rate and variable-rate debt instruments. The Company’s
objective is to mitigate the variability in cash outflows that result from changes in interest rates by maintaining a
balanced mix of fixed-rate and variable-rate debt obligations. In order to achieve these objectives, the Company
has entered into interest rate swaps. Interest rate swaps involve the periodic exchange of payments without the
exchange of underlying principal or notional amounts. Net payments are recognized as an adjustment to interest
expense.
The Company formally documents its hedge relationships, including identifying the hedging instruments and
the hedged items, as well as its risk management objectives and strategies for undertaking the hedge transaction.
On the date the derivative is entered into, the Company designates the type of derivative as a fair value hedge or
cash flow hedge, and accounts for the derivative in accordance with its designation as prescribed by the FASB
standards on accounting for derivative instruments and hedging activities. At inception and at least quarterly
thereafter, the Company formally assesses whether the derivatives that are used in hedging transactions are highly
effective in offsetting changes in the fair value or cash flows of the hedged item. All components of each
derivative financial instrument’s gain or loss are included in the assessment of hedge effectiveness.
The Company accounts for its derivatives as either an asset or liability measured at its fair value. The fair
value is based upon quoted market prices obtained from third-party financial institutions. For a derivative
instrument that has been formally designated as a fair value hedge, fair value gains or losses on the derivative
instrument are reported in earnings, together with offsetting fair value gains or losses on the hedged item that are
attributable to the risk being hedged. For derivatives that have been formally designated as a cash flow hedge,
the effective portion of changes in the fair value of the derivatives is recorded in “accumulated other
comprehensive loss” and the ineffective portion is recorded in earnings. Upon maturity or early termination of an
effective interest rate swap designated as a cash flow hedge, unrealized gains or losses are deferred in
stockholders’ equity, as a component of “accumulated other comprehensive loss,” and are amortized as an
adjustment to interest expense over the period during which the hedged forecasted transaction affects earnings. If
it is determined that a derivative ceases to be a highly effective hedge, the Company discontinues hedge
accounting and any deferred gains or losses related to a discontinued cash flow hedge shall continue to be
reported in “accumulated other comprehensive loss,” unless it is probable that the forecasted transaction will not
occur. If it is probable that the forecasted transaction will not occur by the originally specified time period, the
Company discontinues hedge accounting, and any deferred gains or losses reported in “accumulated other
comprehensive loss” are classified into earnings immediately.
Foreign Currency Risk
The Company is exposed to market risk for changes in foreign exchange rates primarily under certain inter-
company receivables and payables. Foreign exchange forward contracts are used to mitigate the exposure of the
eventual net cash inflows or outflows resulting from these intercompany transactions. The objective is to hedge a
portion of the forecasted foreign currency risk over a rolling 12-month time horizon to mitigate the eventual
impacts of changes in foreign exchange rates on the cash flows of the intercompany transactions. As of
December 31, 2009, the total notional amount of foreign currency forward contracts in U.S. dollars was $50.5
million and principally consist of contracts in Swedish krona and British pounds. Notional amounts represent the
face amount of contractual arrangements and the basis on which currencies are exchanged and are not a measure
of market or credit risk exposure. The Company does not designate these derivative instruments as hedges under
current accounting standards unless the benefits of doing so are material. The Company’s foreign exchange
exposure is not material to the Company’s consolidated financial condition or results of operations. The Company
does not hedge its net investment in non-U.S. subsidiaries because it views those investments as long-term in
nature.
F-13
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(dollars in thousands unless otherwise indicated)