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Note 11 – Financial Instruments
We are exposed to market risk from changes in foreign
currency exchange rates and interest rates, which could
affect operating results, financial position and cash
flows. We manage our exposure to these market risks
through our regular operating and financing activities
and, when appropriate, through the use of derivative
financial instruments. These derivative financial instru-
ments are utilized to hedge economic exposures as well
as reduce earnings and cash flow volatility resulting
from shifts in market rates. As permitted, certain of these
derivative contracts have been designated for hedge
accounting treatment under SFAS No. 133. However,
certain of these instruments do not qualify for hedge
accounting treatment and, accordingly, our results of
operations are exposed to some level of volatility. The
level of volatility will vary with the type and amount of
derivativehedges outstanding, as well as fluctuations in
the currency and interest rate market during the period.
We enter into limited types of derivative contracts,
including interest rate and cross currency interest rate
swap agreements, foreign currency spot, forward and
swap contracts, purchased foreign currency options
and interest rate collars to manage interest rate and
foreign currency exposures. Our primary foreign
currency market exposures include the Japanese yen,
Euro, British pound sterling, Brazilian real and
Canadian dollar. The fair market values of all our
derivative contracts change with fluctuations in interest
rates and/or currency rates and are designed so that
any changes in their values are offset by changes in
the values of the underlying exposures. Derivative
financial instruments are held solely as risk manage-
ment tools and not for trading or speculative purposes.
By their nature, all derivative instruments involve,
to varying degrees, elements of market and credit risk
not recognized in our financial statements. The market
risk associated with these instruments resulting from
currency exchange and interest rate movements is
expected to offset the market risk of the underlying
transactions, assets and liabilities being hedged. We do
not believe there is significant risk of loss in the event
of non-performance by the counterparties associated
with these instruments because these transactions are
executed with adiversified group of major financial
institutions. Further, our policy is to deal with counter-
parties having a minimum investment-grade or better
credit rating. Credit risk is managed through the contin-
uous monitoring of exposures to such counterparties.
Some of our derivative and other material
contracts at December 31, 2004 require us to post cash
collateral or maintain minimum cash balances in
escrow. These cash amounts are reported in our
Consolidated Balance Sheets within Other current
assets or Other long-term assets, depending on when
the cash will be contractually released, as presented in
Note 1 to the Consolidated Financial Statements.
Interest Rate Risk Management: We use interest
rate swap agreements to manage our interest rate
exposure and to achieve a desired proportion of
variable and fixed rate debt. These derivatives may be
designated as fair value hedges or cash flow hedges
depending on the nature of the risk being hedged.
Virtually all customer-financing assets earn fixed rates
of interest and a significant portion of those assets
have been matched to secured borrowings through
third party funding arrangements which generally
bear fixed rates of interest. These borrowings are
secured bycustomer-financing assets and are designed
to mature as wecollect principal payments on the
financing assets which secure them. The interest rates
on a significant portion of those loans are fixed. As a
result, these funding arrangements create natural match
funding of the financing assets to the related debt.
At December 31, 2004 and 2003, we had outstand-
ing single currency interest rate swap agreements
with aggregate notional amounts of $2.8 billion and
$2.5 billion, respectively. The net (liability) asset fair
values at December 31, 2004 and 2003 were $(37) and
$46, respectively.
Fair Value Hedges: As of December 31, 2004 and 2003,
pay variable/receive fixed interest rate swaps with
notional amounts of $2.4 billion and $1.7 billion were
designated and accounted for as fair value hedges.
The swaps were structured to hedge the fair value
of related debt by converting them from fixed rate
instruments to variable rate instruments. No ineffec-
tive portion was recorded to earnings during 2004 or
2003. The following is a summary of our fair value
hedges at December 31, 2004:
Weighted-
average
Year First Notional Interest Interest Rate
Debt Instrument Designated Amount Rate Paid Received Basis Maturity
Senior Notes due 2010 2003 $ 700 6.04% 7.13% Libor 2010
Senior Notes due 2013 2003/2004 550 6.01% 7.63% Libor 2013
Notes due 2016 2004 250 5.44% 7.20% Libor 2016
Senior Notes due 2011 2004 250 5.41% 6.88% Libor 2011
Liability to Capital Trust I 2004 600 5.52% 8.00% Libor 2027
Total $2,350