Radio Shack 2009 Annual Report Download - page 80

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NOTE 11 – DERIVATIVE FINANCIAL INSTRUMENTS
We enter into derivative instruments for risk management purposes only, including derivatives designated
as hedging instruments under the FASB’s accounting guidance on the accounting for derivative
instruments and hedging activities. We do not hold or issue derivative financial instruments for trading or
speculative purposes. To qualify for hedge accounting, derivatives must meet defined correlation and
effectiveness criteria, be designated as a hedge and result in cash flows and financial statement effects
that substantially offset those of the position being hedged.
By using these derivative instruments, we expose ourselves, from time to time, to credit risk and market
risk. Credit risk is the potential failure of the counterparty to perform under the terms of the derivative
contract. When the fair value of a derivative contract is positive, the counterparty owes us, which creates
credit risk for us. We minimize this credit risk by entering into transactions with high quality counterparties
and do not anticipate significant losses due to our counterparties’ nonperformance. Market risk is the
adverse effect on the value of a financial instrument that results from a change in the rate or value of the
underlying item being hedged. We minimize this market risk by establishing and monitoring internal
controls over our hedging activities, which include policies and procedures that limit the types and degree
of market risk that may be undertaken.
Interest Rate Swap Agreements: We use interest rate-related derivative instruments to manage our
exposure to fluctuations of interest rates. In June and August 2003, we entered into interest rate swap
agreements with underlying notional amounts of debt of $100 million and $50 million, respectively, and both
with maturities in May 2011. These swaps effectively convert a portion of our long-term fixed rate debt to a
variable rate. We entered into these agreements to balance our fixed versus floating rate debt portfolio to
continue to take advantage of lower short-term interest rates. Under these agreements, we have contracted
to pay a variable rate of LIBOR plus a markup and to receive fixed rates of 7.375%.
The swap agreements were originally designated as fair value hedges of the related debt and met the
requirements to be accounted for under the short-cut method, resulting in no ineffectiveness in the hedging
relationship. The periodic interest settlements, which occur at the same interval as the interest payments on
the 2011 Notes, are recorded as interest expense. The gain or loss on these derivatives, as well as the
offsetting loss or gain on the related debt, was recognized in current earnings, but had a net earnings
effect of zero due to short-cut method accounting.
In September 2009, we repurchased $43.2 million of our 7.375% unsecured notes due in 2011. A portion of
these notes were hedged by our interest rate swaps. Upon repurchase of these notes, we were required to
discontinue the hedge accounting treatment associated with these derivative instruments which used the
short-cut method. We intend to hold these instruments until their maturities. Changes in fair value of these
instruments are recorded in earnings as an adjustment to interest expense.