Air Canada 2013 Annual Report Download - page 57

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2013 Management’s Discussion and Analysis
57
The following are the current derivatives employed in interest rate risk management activities and the adjustments recorded
during 2013:
• As at December 31, 2013, Air Canada 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 million
(US$58 million) (2012 – $65 million (US$66 million)). 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 million in favour of
Air Canada (2012 – $13 million in favour of Air Canada). These derivative instruments have not been designated as
hedges for accounting purposes and are recorded at fair value. In 2013, a Loss of $1 million was recorded in Gain (loss) on
financial instruments recorded at fair value related to these derivatives (2012 – $2 million gain).
Interest income includes $29 million (2012 – $33 million) 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
Air Canada’s financial results are reported in Canadian dollars, however a large portion of its revenues, expenses, debt
obligations and capital commitments are in foreign currencies, primarily in U.S. dollars. Foreign exchange risk is the risk that
fluctuations in foreign exchange rates will adversely impact operating results and cash flows. Air Canada’s risk management
objective is to reduce cash flow risk related to foreign denominated cash flows.
Air Canada’s cash inflows are primarily in Canadian dollars, while a large portion of its outflows are in U.S. dollars. This
unbalanced mix results in an annual U.S. dollar shortfall from operations. In order to mitigate this imbalance, Air Canada has
adopted a number of risk management strategies, which include:
• The practice of converting excess revenues from offshore currencies into U.S. dollars. In 2013, this conversion generated
coverage for approximately 25% of the imbalance.
• Holding U.S. cash reserves as an economic hedge against changes in the value of the U.S. dollar. U.S. dollar cash and
short-term investment balances, as at December 31, 2013, amounted to $791 million (US$743 million) ($581 million
(US$584 million) as at December 31, 2012).
• Locking in the foreign exchange rate through the use of a variety of foreign exchange derivatives which have maturity
dates corresponding to the forecasted dates of U.S. dollar shortfalls.
The target coverage of the above strategies is to cover 50% of the net U.S. dollar exposure on a rolling 12 month basis. The
level of foreign exchange derivatives entered into and their related maturity dates are dependent upon a number of factors,
including the amount of foreign revenue conversion available, U.S dollar net cash flows, as well as the amount attributed to
aircraft and debt payments. Based on the notional amount of currency derivatives outstanding at December 31, 2013, as
further described below, and the value of U.S. cash reserves, approximately 50% of net U.S. cash outflows are hedged in 2014.
• As at December 31, 2013, Air Canada had outstanding foreign currency options and swap agreements to purchase U.S.
dollars and Euros against Canadian dollars on $1,645 million (US$1,547 million) and $72 million (EUR $34 million, GBP
$16 million) which mature in 2014 and 2015 at a weighted average rate of $1.0341 per $1.00 U.S. dollar (2012 –
$1,289 million (US$1,296 million) which matured in 2013). The fair value of these foreign currency contracts as at
December 31, 2013 was $13 million in favour of Air Canada (2012 – less than $1 million in favour of Air Canada). These
derivative instruments have not been designated as hedges for accounting purposes and are recorded at fair value. In
2013, a gain of $68 million was recorded in Foreign exchange gain (loss) related to these derivatives (2012 – $20 million
gain).
Fuel Price Risk Management
Fuel price risk is the risk that future cash flows will fluctuate because of changes in jet fuel prices. In order to manage its
exposure to jet fuel prices and to help mitigate volatility in operating cash flows, Air Canada enters into derivative contracts
with financial intermediaries.