Banana Republic 2005 Annual Report Download - page 34

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32 gap inc. 2005 annual report
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We operate in foreign countries, which exposes us to market risk associated with foreign currency exchange rate fluctuations. Our risk management
policy is to hedge substantially all forecasted merchandise purchases for foreign operations using foreign exchange forward contracts. We also use
forward contracts to hedge our market risk exposure associated with foreign currency exchange rate fluctuations for certain intercompany loans and
balances denominated in currencies other than the functional currency of the entity holding or issuing the intercompany loan or balance. These con-
tracts are entered into with large, reputable financial institutions, thereby minimizing the credit exposure from our counter-parties. The principal
currencies hedged during fiscal 2005 were the Euro, British pound, Japanese yen, and Canadian dollar. Our use of derivative financial instruments
represents risk management; we do not use derivative financial instruments for trading purposes. Additional information is presented in Note F to
the Consolidated Financial Statements.
We have performed a sensitivity analysis as of January 28, 2006 and January 29, 2005, based on a model that measures the change in fair values of
our derivative financial instruments arising from a hypothetical 10 percent adverse change in the level of foreign currency exchange rates relative to
the U.S. dollar with all other variables held constant. The analysis covers all foreign exchange derivative financial instruments offset by the underlying
exposures. The foreign currency exchange rates used in the model were based on the spot rates in effect at January 28, 2006 and January 29, 2005.
The sensitivity analysis indicated that a hypothetical 10 percent adverse movement in foreign currency exchange rates would have had an unfavor-
able impact on the fair values of our foreign exchange derivative financial instruments, net of the underlying exposures, of $30 million at January 28,
2006 and $23 million at January 29, 2005.
We hedge the net assets of certain international subsidiaries to offset the translation and economic exposures related to our investments in these
subsidiaries. The change in fair value of the hedging instrument is reported in accumulated other comprehensive earnings (loss) within shareholders’
equity to offset the foreign currency translation adjustments on the investments.
In addition, we used a cross-currency interest rate swap to swap the interest and principal payable of $50 million debt securities of our Japanese
subsidiary, Gap (Japan) KK, from a fixed interest rate of 6.25 percent, payable in U.S. dollars, to 6.1 billion Japanese yen with a fixed interest rate of
2.43 percent. These debt securities are recorded on the Consolidated Balance Sheets at their issuance amount, net of unamortized discount. The
derivative instruments are recorded in the Consolidated Balance Sheets at their fair value as of January 28, 2006.
We have limited exposure to interest rate fluctuations on our borrowings. The interest on our long-term debt is set at a fixed coupon, with the excep-
tion of the interest rates payable by us on our outstanding $500 million notes due December 2008, of which only $138 million remains outstanding,
which are subject to change based on our long-term senior secured credit ratings. The interest rates earned on our cash and equivalents will fluctuate
in line with short-term interest rates.
In March 2002, we issued $1.4 billion aggregate principal amount of 5.75 percent senior convertible notes due March 15, 2009, and received pro-
ceeds of $1.4 billion in cash, net of underwriting and other fees. On March 11, 2005, we called for the full redemption of these notes. The redemption
was completed by March 31, 2005. Note holders had the option of receiving either cash at a redemption price equal to 102.46 percent of the princi-
pal amount of the note, plus accrued interest, for a total of approximately $1,027 per $1,000 principal amount of notes, or alternatively, converting
their notes into approximately 62.03 shares of Gap, Inc. common stock per $1,000 principal amount. As of March 31, 2005, $1.4 billion of principal
was converted into 85,143,950 shares of Gap, Inc. common stock and approximately $0.5 million was paid in cash redemption.
In November 2001, we issued $500 million aggregate principal amount of debt securities at an original annual interest rate of 8.80 percent, due
December 15, 2008 (the “2008 Notes”). Interest on the notes is payable semi-annually. As a result of prior and current fiscal year changes to our
long-term credit ratings the interest payable by us on the 2008 Notes was 9.55 percent per annum as of January 28, 2006. We repurchased $38
million and $325 million of the 2008 Notes during fiscal 2003 and fiscal 2004, respectively. These debt securities are recorded in the Consolidated
Balance Sheets at their issuance amount net of repurchases and unamortized discount.