Xerox 2006 Annual Report Download - page 83

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per-share data and unless otherwise indicated)
do not qualify for hedge accounting but are effective as
economic hedges of our inventory purchases and currency
exposure. These derivative contracts are accounted for
using the mark-to-market accounting method and
accordingly are exposed to some level of volatility. Under
this method, the contracts are carried at their fair value on
our consolidated balance sheet within Other assets and
Other liabilities. The level of volatility will vary with the
type and amount of derivative hedges outstanding, as well
as fluctuations in the currency and interest rate market
during the period. The related cash flow impacts of all of
our derivative activities are reflected as cash flows from
operating activities.
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 and net purchased foreign currency
options to manage interest rate and foreign currency
exposures. Our primary foreign currency market
exposures include the Japanese Yen, Euro, British pound
sterling, Canadian dollar and Brazilian real. 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
management 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 a diversified group of major financial institutions.
Further, our policy is to deal with counterparties having a
minimum investment-grade or better credit rating. Credit
risk is managed through the continuous monitoring of
exposures to such counterparties.
Some of our derivative and other material contracts
at December 31, 2006 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-Summary of Significant
Accounting Policies 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 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
by customer-financing assets and are designed to mature
as we collect 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, 2006 and 2005, we had outstanding
single currency interest rate swap agreements with
aggregate notional amounts of $1.7 billion and $2.1
billion, respectively. The net liability fair values at
December 31, 2006 and 2005 were $41 and $40,
respectively.
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