Royal Caribbean Cruise Lines 2013 Annual Report Download - page 94
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DERIVATIVE INSTRUMENTS
We are exposed to market risk attributable to changes
in interest rates, foreign currency exchange rates and
fuel prices. We manage these risks through a combina-
tion of our normal operating and financing activities
and through the use of derivative financial instruments
pursuant to our hedging practices and policies. The
financial impact of these hedging instruments is pri-
marily offset by corresponding changes in the under-
lying exposures being hedged. We achieve this by
closely matching the amount, term and conditions
of the derivative instrument with the underlying risk
being hedged. Although certain of our derivative
financial instruments do not qualify or are not
accounted for under hedge accounting, we do not
hold or issue derivative financial instruments for
trading or other speculative purposes. We monitor
our derivative positions using techniques including
market valuations and sensitivity analyses.
We enter into various forward, swap and option con-
tracts to manage our interest rate exposure and to
limit our exposure to fluctuations in foreign currency
exchange rates and fuel prices. These instruments are
recorded on the balance sheet at their fair value and
the vast majority are designated as hedges. We also
have non-derivative financial instruments designated
as hedges of our net investment in our foreign opera-
tions and investments.
At inception of the hedge relationship, a derivative
instrument that hedges the exposure to changes in
the fair value of a firm commitment or a recognized
asset or liability is designated as a fair value hedge.
A derivative instrument that hedges a forecasted
transaction or the variability of cash flows related to
a recognized asset or liability is designated as a cash
flow hedge.
Changes in the fair value of derivatives that are
designated as fair value hedges are offset against
changes in the fair value of the underlying hedged
assets, liabilities or firm commitments. Gains and
losses on derivatives that are designated as cash flow
hedges are recorded as a component of Accumulated
other comprehensive income (loss) until the underly-
ing hedged transactions are recognized in earnings.
The foreign currency transaction gain or loss of our
non-derivative financial instruments designated as
hedges of our net investment in foreign operations
and investments are recognized as a component of
Accumulated other comprehensive income (loss)
along with the associated foreign currency translation
adjustment of the foreign operation.
On an ongoing basis, we assess whether derivatives
used in hedging transactions are “highly effective”
in offsetting changes in the fair value or cash flow
of hedged items. We use the long-haul method to
assess hedge effectiveness using regression analysis
for each hedge relationship under our interest rate,
foreign currency and fuel hedging programs. We
apply the same methodology on a consistent basis
for assessing hedge effectiveness to all hedges within
each hedging program (i.e., interest rate, foreign cur-
rency and fuel). We perform regression analyses over
an observation period of up to three years, utilizing
market data relevant to the hedge horizon of each
hedge relationship. High effectiveness is achieved
when a statistically valid relationship reflects a high
degree of offset and correlation between the changes
in the fair values of the derivative instrument and the
hedged item. The determination of ineffectiveness is
based on the amount of dollar offset between the
change in fair value of the derivative instrument and
the change in fair value of the hedged item at the
end of the reporting period. If it is determined that a
derivative is not highly effective as a hedge or hedge
accounting is discontinued, any change in fair value
of the derivative since the last date at which it was
determined to be effective is recognized in earnings.
In addition, the ineffective portion of our highly effec-
tive hedges is immediately recognized in earnings and
reported in Other income (expense) in our consoli-
dated statements of comprehensive income (loss).
Cash flows from derivative instruments that are desig-
nated as fair value or cash flow hedges are classified
in the same category as the cash flows from the
underlying hedged items. In the event that hedge
accounting is discontinued, cash flows subsequent to
the date of discontinuance are classified within invest-
ing activities. Cash flows from derivative instruments
not designated as hedging instruments are classified
as investing activities.
We consider the classification of the underlying hedged
item’s cash flows in determining the classification for
the designated derivative instrument’s cash flows. We
classify derivative instrument cash flows from hedges
of benchmark interest rate or hedges of fuel expense
as operating activities due to the nature of the hedged
item. Likewise, we classify derivative instrument cash
flows from hedges of foreign currency risk on our
newbuild ship payments as investing activities. Cash
flows from derivative instruments not designated
under hedge accounting, such as our fuel call options,
are classified as investing activities.