The Gap 2008 Annual Report Download - page 46

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
We operate in foreign countries, which exposes us to market risk associated with foreign currency exchange rate
fluctuations. Our risk management policy is to hedge a significant portion of forecasted merchandise purchases for
foreign operations and forecasted royalty payments using foreign exchange forward contracts. We also use
forward contracts to hedge our market risk exposure associated with foreign currency exchange rate fluctuations
for certain intercompany loans and balances denominated in currencies other than the functional currency of the
entity holding or issuing the intercompany loan or balance. These contracts are entered into with large, reputable
financial institutions, which are monitored for counterparty risk. The principal currencies hedged during fiscal
2008 were U.S. dollars, Euro, British pounds, Japanese yen, and Canadian dollars. Our use of derivative financial
instruments represents risk management; we do not use derivative financial instruments for trading purposes.
Additional information is presented in Note 8 of Notes to the Consolidated Financial Statements. The derivative
financial instruments are recorded in the Consolidated Balance Sheets at their fair value as of the balance
sheet dates.
We have performed a sensitivity analysis as of January 31, 2009 and February 2, 2008, based on a model that
measures the impact of a hypothetical 10 percent adverse change in the level of foreign currency exchange rates to
U.S. dollars (with all other variables held constant) on our underlying exposure, net of derivative financial
instruments. The foreign currency exchange rates used in the model were based on the spot rates in effect at
January 31, 2009 and February 2, 2008. The sensitivity analysis indicated that a hypothetical 10 percent adverse
movement in foreign currency exchange rates would have had an unfavorable impact on the underlying cash flow
exposure, net of our foreign exchange derivative financial instruments, of $34 million at January 31, 2009 and
$37 million at February 2, 2008.
We do not have significant exposure to interest rate fluctuations on our borrowings. We use a cross-currency interest
rate swap to swap the interest and principal payable of the $50 million debt of our Japanese subsidiary, Gap (Japan)
KK, from a fixed interest rate of 6.25 percent, payable in U.S. dollars, to 6.1 billion Japanese yen with a fixed interest
rate of 2.43 percent. This debt was repaid in March 2009. The fair value of this debt was $49 million and $51 million as
of January 31, 2009 and February 2, 2008, respectively and classified as current maturities of long-term debt on the
Consolidated Balance Sheet as of January 31, 2009. In connection with the repayment of $50 million related to the
maturity of this debt, we settled the corresponding cross-currency interest rate swap in March 2009.
In addition, we invest in fixed and variable income investments classified as cash, cash equivalents, and short-term
investments. Our cash, cash equivalents, and short-term investments are placed primarily in treasury and prime
money market funds, domestic commercial paper, and bank securities. Our cash equivalents and short-term
investments are stated at amortized cost, which approximates fair market value due to the short maturities of
these instruments. An increase in interest rates of 10 percent would not have a material impact on the value of
these investments. However, changes in interest rates would impact the interest income derived from our
investments. We earned interest income of $37 million, $117 million, and $131 million in fiscal 2008, 2007, and
2006, respectively.
34 Gap Inc. Form 10-K