Union Pacific 2005 Annual Report Download - page 58

Download and view the complete annual report

Please find page 58 of the 2005 Union Pacific annual report below. You can navigate through the pages in the report by either clicking on the pages listed below, or by using the keyword search tool below to find specific information within the annual report.

Page out of 100

  • 1
  • 2
  • 3
  • 4
  • 5
  • 6
  • 7
  • 8
  • 9
  • 10
  • 11
  • 12
  • 13
  • 14
  • 15
  • 16
  • 17
  • 18
  • 19
  • 20
  • 21
  • 22
  • 23
  • 24
  • 25
  • 26
  • 27
  • 28
  • 29
  • 30
  • 31
  • 32
  • 33
  • 34
  • 35
  • 36
  • 37
  • 38
  • 39
  • 40
  • 41
  • 42
  • 43
  • 44
  • 45
  • 46
  • 47
  • 48
  • 49
  • 50
  • 51
  • 52
  • 53
  • 54
  • 55
  • 56
  • 57
  • 58
  • 59
  • 60
  • 61
  • 62
  • 63
  • 64
  • 65
  • 66
  • 67
  • 68
  • 69
  • 70
  • 71
  • 72
  • 73
  • 74
  • 75
  • 76
  • 77
  • 78
  • 79
  • 80
  • 81
  • 82
  • 83
  • 84
  • 85
  • 86
  • 87
  • 88
  • 89
  • 90
  • 91
  • 92
  • 93
  • 94
  • 95
  • 96
  • 97
  • 98
  • 99
  • 100

providing several corridors to key Mexican gateways. We serve the western two-thirds of the country and
maintain coordinated schedules with other rail carriers for the handling of freight to and from the Atlantic Coast,
the Pacific Coast, the Southeast, the Southwest, Canada, and Mexico. Export and import traffic is moved through
Gulf Coast and Pacific Coast ports and across the Mexican and Canadian borders. Railroad freight is comprised of
six commodity groups (percent of total commodity revenues for the year ended December 31, 2005: agricultural
(15%), automotive (10%), chemicals (14%), energy (20%), industrial products (22%), and intermodal (19%)).
Discontinued Operations – The discontinued operations represent the operations of OTC and Motor Cargo,
which were sold through an initial public offering in 2003.
2. Financial Instruments
Strategy and Risk – We may use derivative financial instruments in limited instances for other than trading
purposes to assist in managing risk related to changes in fuel prices and to achieve our interest rate objectives. We
are not a party to leveraged derivatives and, by policy, do not use derivative financial instruments for speculative
purposes. Financial instruments qualifying for hedge accounting must maintain a specified level of effectiveness
between the hedging instrument and the item being hedged, both at inception and throughout the hedged period.
We formally document the nature and relationships between the hedging instruments and hedged items, as well
as our risk-management objectives, strategies for undertaking the various hedge transactions, and method of
assessing hedge effectiveness. We may use swaps, collars, futures, and/or forward contracts to mitigate the
downside risk of adverse price movements and to hedge the exposure to variable cash flows. The use of these
instruments also limits future benefits from favorable movements.
The purpose of these programs is to assist in protecting our operating margins and overall profitability from
adverse fuel price changes or interest rate fluctuations.
Market and Credit Risk – We address market risk related to derivative financial instruments by selecting
instruments with value fluctuations that highly correlate with the underlying hedged item. Credit risk related to
derivative financial instruments, which is minimal, is managed by requiring high credit standards for
counterparties and periodic settlements. At December 31, 2005 and 2004, we were not required to provide
collateral, nor had we received collateral, relating to our hedging activities.
Determination of Fair Value – We determined the fair values of our derivative financial instrument positions at
December 31, 2005 and 2004 based upon current fair values as quoted by recognized dealers or developed based
upon the present value of expected future cash flows discounted at the applicable U.S. Treasury rate, LIBOR, or
swap spread.
Interest Rate Fair Value Hedges – We manage our overall exposure to fluctuations in interest rates by adjusting
the proportion of fixed and floating rate debt instruments within our debt portfolio over a given period. We
generally manage the mix of fixed and floating rate debt through the issuance of targeted amounts of each as debt
matures or as we require incremental borrowings. We employ derivatives as one of the tools to obtain the targeted
mix. In addition, we also obtain flexibility in managing interest costs and the interest rate mix within our debt
portfolio by evaluating the issuance of and managing outstanding callable fixed-rate debt securities.
Swaps allow us to convert debt from fixed rates to variable rates and thereby hedge the risk of changes in the
debt’s fair value attributable to the changes in the benchmark interest rate (LIBOR). We accounted for the swaps
as fair value hedges using the short-cut method pursuant to FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities; therefore, we did not record any ineffectiveness within our Consolidated
Financial Statements.
52