Air Canada 2013 Annual Report Download - page 134

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2013 Air Canada Annual Report
134
Risk Management
Under its risk management policy, the Corporation manages its interest rate risk, foreign exchange risk, share-based
compensation risk and market risk (e.g. fuel price risk) through the use of various interest rate, foreign exchange, fuel and
other derivative financial instruments. The Corporation uses derivative financial instruments only for risk management
purposes, not for generating trading profit. As such, any change in cash flows associated with derivative instruments is
designed to be offset by changes in cash flows related to the risk being hedged.
As noted below, the Corporation uses derivative instruments to provide economic hedges to mitigate various risks. The
derivative fair values represent the amount of the consideration that could be exchanged in an arm’s length transaction
between willing parties who are under no compulsion to act. Fair value of these derivatives is determined using prices in active
markets, where available. When no such market is available, valuation techniques are applied such as discounted cash flow
analysis. The valuation technique incorporates all factors that would be considered in setting a price, including the
Corporation’s own credit risk and the credit risk of the counterparty.
Interest Rate Risk
Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes
in market interest rates.
The Corporation enters into both fixed and floating rate debt and also leases certain assets where the rental amount
fluctuates based on changes in short term interest rates. The Corporation manages interest rate risk on a portfolio basis and
seeks financing terms in individual arrangements that are most advantageous taking into account all relevant factors,
including credit margin, term and basis. The risk management objective is to minimize the potential for changes in interest
rates to cause adverse changes in cash flows to the Corporation. The short-term investment portfolio which earns a floating
rate of return is an economic hedge for a portion of the floating rate debt.
The ratio of fixed to floating rate obligations outstanding is designed to maintain flexibility in the Corporation’s capital
structure and is based upon a long term objective of 60% fixed and 40% floating but allows flexibility in the short-term to
adjust to prevailing market conditions. The ratio at December 31, 2013 is 74% fixed and 26% floating, including the effects of
interest rate swap positions (71% and 29%, respectively as at December 31, 2012). The following are the current derivatives
employed in interest rate risk management activities and the adjustments recorded during 2013:
• As at December 31, 2013, the Corporation had two interest rate swap agreements in place with terms to July 2022 and
January 2024 relating to two Boeing 767 aircraft financing agreements with an aggregate notional value of $62 (US$58)
(2012 – $65 (US$66)). These swaps convert the lease payments on the two aircraft leases from fixed to floating rates.
The fair value of these contracts as at December 31, 2013 was $10 in favour of the Corporation (2012 – $13 in favour of
the Corporation). These derivative instruments have not been designated as hedges for accounting purposes and are
recorded at fair value. During 2013, a loss of $1 was recorded in Gain on financial instruments recorded at fair value
related to these derivatives (2012 – $2 gain).
Interest income includes $29 (2012 – $33) related to Cash and cash equivalents and Short-term investments, which are
classified as held for trading. Interest expense reflected on the consolidated statement of operations relates to financial
liabilities recorded at amortized cost.
Foreign Exchange Risk
The Corporation’s financial results are reported in Canadian dollars, while a large portion of its revenues, expenses, debt
obligations and capital commitments are in foreign currencies, primarily in US dollars. Foreign exchange risk is the risk that
fluctuations in foreign exchange rates will adversely impact operating results and cash flows.
The Corporation’s risk management objective is to reduce cash flow risk related to foreign denominated cash flows.