Air Canada 2014 Annual Report Download - page 60

6060 2014 Annual Report
currencies, primarily in U.S. dollars. Foreign exchange
risk is the risk that fluctuations in foreign exchange
rates may have on operating results and cash flows.
In order to manage exposure to the U.S dollar
and other foreign exchange exposures, Air Canada
holds U.S. dollar cash reserves and enters into
currency derivative contracts. These derivatives and
U.S. dollar cash reserves serve to mitigate the cash
flow exposure from adverse currency movements.
The result of these hedging activities is recorded as
a Foreign exchange gain or loss in Non-operating
expense on Air Canada’s consolidated statement of
operations (not within Operating income).
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 program to convert excess
revenues from offshore currencies into U.S. dollars.
In 2014, this conversion generated coverage for
approximately 23% of the imbalance.
For the remainder of the currency imbalance (i.e.
the net U.S. dollar shortfall), Air Canada has a target
coverage of 60% on a rolling 18-month basis utilizing
the following risk management strategies:
• Holding U.S. dollar 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, 2014 amounted
to $717 million (US$620 million) ($791 million
(US$743 million) as at December 31, 2013). In
2014, an unrealized gain of $58 million (unrealized
gain of $44 million in 2013) was recorded in
Foreign exchange gain (loss) on Air Canada’s
consolidated statement of operations reflecting
the change in Canadian equivalent market value
of the U.S. dollar cash and short-term investment
balances held.
• 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 net outflows.
The target coverage of the above strategies is to
cover 60% of the net U.S dollar exposure on a
rolling 18-month basis. The level of foreign exchange
derivatives entered into and their related maturity
dates are dependent upon a number of factors,
which include 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, 2014, as
further described below, approximately 69% of net
U.S. cash outflows are hedged for 2015 and 13% for
2016, resulting in derivative coverage of 52% over the
next 18 months.
As at December 31, 2014, Air Canada had outstanding
foreign currency options and swap agreements,
settling in 2015 and 2016, to purchase at maturity
$2,658 million (US$2,292 million) of U.S. dollars at
a weighted average rate of $1.0884 per $1.00 U.S.
dollar (2013 – $1,645 million (US$1,547 million) with
settlements in 2014 and 2015 at a weighted average
rate of $1.0341 per $1.00 U.S. dollar). Air Canada
also has protection in place to sell a portion of its
excess Euros and Sterling (EUR $35 million, GBP
$27 million) which settle in 2015 at weighted average
rates of $1.2806 and $1.6217 per $1.00 U.S. dollar
respectively (2013 - EUR $34 million, GBP $16 million
with settlement in 2014 at weighted average rates
of $1.3511 and $1.6130 respectively per $1.00 U.S.
dollar).
The hedging structures put in place have various
option pricing features, such as knock-out terms and
profit cap limitations, and based on the assumed
volatility used in the fair value calculation, the
fair value of these foreign currency contracts as
at December 31, 2014 was $30 million in favour
of Air Canada (2013 – $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 2014, a gain of
$75 million was recorded in Foreign exchange gain
(loss) on Air Canada’s consolidated statement of
operations related to these derivatives (2013 –
$68 million gain). In 2014, foreign exchange
derivative contracts cash settled with a net fair
value of $58 million in favour of Air Canada
($56 million in 2013 in favour of Air Canada).
INTEREST RATE RISK MANAGEMENT
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.
Air Canada enters into both fixed and floating rate
debt and leases certain assets where the rental
amount fluctuates based on changes in short-term
interest rates. Air Canada 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 Air Canada. The cash and short-term