Xerox 2006 Annual Report Download - page 84

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per-share data and unless otherwise indicated)
Fair Value Hedges: As of December 31, 2006 and 2005, pay variable/receive fixed interest rate swaps with
notional amounts of $1.4 billion and $1.8 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 ineffective portion was recorded to earnings during 2006, 2005, or 2004. The following is a summary
of our fair value hedges at December 31, 2006:
Debt Instrument
Year First
Designated
Notional
Amount
Net
Liability
Fair
Value
Weighted-
average
Interest
Rate Paid
Interest
Rate Received Basis Maturity
Senior Notes due 2010 ............... 2003/2005 $ 400 $ 8.3 7.83% 7.13% Libor 2010
Notes due 2016 ..................... 2004 250 5.7 7.62% 7.20% Libor 2016
Senior Notes due 2011 ............... 2004 250 6.9 7.84% 6.88% Libor 2011
Liability to Capital Trust I ............. 2005 450 21.4 7.46% 8.00% Libor 2027
Total ......................... $1,350 $42.3
Cash Flow Hedges: During 2006, pay fixed/receive
variable interest rate swaps with notional amounts of
£200 million ($392) and a net asset fair value of $1,
associated with the Xerox Finance Limited GE Capital
borrowing were designated and accounted for as cash
flow hedges. The swaps were structured to hedge the
LIBOR interest rate of the debt by converting it from a
variable rate instrument to a fixed rate instrument. No
ineffective portion was recorded to earnings during 2006
and 2005.
Terminated Swaps: During 2006, we terminated
interest rate swaps with a notional value of $400 and a net
liability fair value of $8 which had previously been
designated fair value hedges of certain indebtedness. The
fair value adjustments to these debt instruments are
amortized to interest expense over the remaining term of
the notes. During 2005, we terminated interest rate swaps
with a notional value of $1.3 billion and a net fair liability
value of $29 which had previously been designated as fair
value hedges of certain indebtedness. The fair value
adjustment to these debt instruments are being amortized
to interest expense over the remaining term of the notes.
In 2006, 2005 and 2004, the amortization of these fair
value adjustments reduced interest expense by $9, $11
and $9, respectively.
Foreign Exchange Risk Management: We may use
certain derivative instruments to manage the exposures
associated with the foreign currency exchange risks
discussed below.
Issuance of foreign currency denominated debt
• We enter into cross-currency interest rate swap
agreements to swap the proceeds and related
interest payments with a counterparty. In return, we
receive and effectively denominate the debt in local
functional currencies.
• We utilize forward exchange contracts to hedge the
currency exposure for interest payments on foreign
currency denominated debt.
• These derivatives may be designated as fair value
hedges or cash flow hedges depending on the
nature of the risk being hedged.
Foreign currency denominated assets and liabilities
• We generally utilize forward foreign exchange
contracts and purchased option contracts to hedge
these exposures.
• Changes in the value of these currency derivatives
are recorded in earnings together with the offsetting
foreign exchange gains and losses on the
underlying assets and liabilities.
Purchases of foreign-sourced inventory
• We generally utilize forward foreign exchange
contracts and purchased option contracts to hedge
these anticipated transactions. These contracts
generally mature in six months or less.
• Although these contracts are intended to
economically hedge foreign currency risks to the
extent possible, the differences between the
contract terms of our derivatives and the underlying
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