Quest Diagnostics 2012 Annual Report Download - page 86

F- 13
Derivative Financial Instruments
The Company uses derivative financial instruments to manage its exposure to market risks for changes in interest rates
and foreign currencies. This strategy includes the use of interest rate swap agreements, forward starting interest rate swap
agreements, treasury lock agreements and foreign currency forward contracts to manage its exposure to movements in interest
and currency rates. The Company has established policies and procedures for risk assessment and the approval, reporting and
monitoring of derivative financial instrument activities. These policies prohibit holding or issuing derivative financial
instruments for speculative purposes. The Company does not enter into derivative financial instruments that contain credit-risk-
related contingent features or requirements to post collateral.
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 or their investment cash flows 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 primary objective is to
achieve the lowest overall cost of funding while managing the variability in cash outflows within an acceptable range. In order
to achieve this objective, 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 settlements between the counterparties are
recognized as an adjustment to interest expense.
The Company accounts for these derivatives as either an asset or liability measured at its fair value. The fair value is
based upon model-derived valuations in which all significant inputs are observable in active markets and includes an
adjustment for the credit risk of the obligor's non-performance. 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 income (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 income (loss), and are amortized as an adjustment to
interest expense over the period during which the hedged forecasted transaction affects earnings. At inception and 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. 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 income (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 income (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 intercompany
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. 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.
Comprehensive Income (Loss)
Comprehensive income (loss) encompasses all changes in stockholders' equity (except those arising from transactions
with stockholders) and includes net income, net unrealized gains or losses on available-for-sale securities, foreign currency
translation adjustments and deferred gains and losses related to certain derivative financial instruments (see Note 13).
QUEST DIAGNOSTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
(dollars in thousands unless otherwise indicated)