Xerox 2008 Annual Report Download - page 74

Notes to the Consolidated
Financial Statements
(in millions, except per share data and
unless otherwise indicated)
currency market exposures include the Yen, Euro, and Pound
Sterling. 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.
We are required to recognize all derivative instruments as either
assets or liabilities at fair value in the balance sheet. As permitted,
certain of these derivative contracts have been designated for
hedge accounting treatment. Certain of our derivatives that do not
qualify for hedge accounting are effective as economic hedges.
These derivative contracts are likewise required to be recognized
each period at fair value and therefore do result in some level of
volatility. 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.
By their nature, all derivative instruments involve, to varying
degrees, elements of market and credit risk. 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.
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.
Fair Value Hedges
For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative as well as the offsetting
loss or gain on the hedged item attributable to the hedged risk are recognized in current earnings. As of December 31, 2008 and 2007, pay
variable/receive fixed interest rate swaps with notional amounts of $675 and $1.1 billion with a net asset (liability) fair value of $53 and
$(6), respectively, 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
2008, 2007, or 2006. The following is a summary of our fair value hedges at December 31, 2008:
Debt Instrument Year First Designated Notional Amount
Net
Fair
Value
Weighted
Average
Interest
Rate Paid Interest Rate Received Basis Maturity
Notes due 2016 2004 $250 $39 5.43% 7.20% Libor 2016
Senior Notes due 2011 2004 125 8 5.28% 6.88% Libor 2011
Liability to Capital Trust I 2005 300 6 5.64% 8.00% Libor 2027
Total $675 $53
72 Xerox 2008 Annual Report