Estee Lauder 2008 Annual Report Download - page 73

THE EST{E LAUDER COMPANIES INC. 71
nature of the risk being hedged, how the hedging instru-
ments’ effectiveness in offsetting the hedged risk will be
assessed prospectively and retrospectively, and a descrip-
tion of the method of measuring ineffectiveness. This
process includes linking all derivatives that are designated
as fair-value, cash-fl ow, or foreign-currency hedges to
specifi c assets and liabilities on the balance sheet or
to specifi c fi rm commitments or forecasted transactions.
We also formally assess, both at the hedge’s inception
and on an ongoing basis, whether the derivatives that are
used in hedging transactions are highly effective in offset-
ting changes in fair values or cash fl ows of hedged items.
If it is determined that a derivative is not highly effective,
then we will be required to discontinue hedge accounting
with respect to that derivative prospectively.
Foreign Exchange Risk Management
We enter into foreign currency forward contracts to hedge
anticipated transactions, as well as receivables and pay-
ables denominated in foreign currencies, for periods
consistent with our identifi ed exposures. The purpose of
the hedging activities is to minimize the effect of foreign
exchange rate movements on our costs and on the cash
fl ows that we receive from foreign subsidiaries. The major-
ity of foreign currency forward contracts are denominated
in currencies of major industrial countries and are with
large fi nancial institutions rated as strong investment
grade by a major rating agency. We also enter into foreign
currency option contracts to hedge anticipated transac-
tions where there is a high probability that anticipated
exposures will materialize. The foreign currency forward
and option contracts entered into to hedge anticipated
transactions have been designated as cash-fl ow hedges.
Hedge effectiveness of foreign currency forward contracts
is based on a hypothetical derivative methodology and
excludes the portion of fair value attributable to the spot-
forward difference which is recorded in current-period
earnings. Hedge effectiveness of foreign currency option
contracts is based on a dollar offset methodology. The
ineffective portion of both foreign currency forward
and option contracts is recorded in current-period earn-
ings. For hedge contracts that are no longer deemed
highly effective, hedge accounting is discontinued and
gains and losses accumulated in other comprehensive
income are reclassifi ed to earnings when the underlying
forecasted transaction occurs. If it is probable that
the forecasted transaction will no longer occur, then any
gains or losses accumulated in other comprehensive
income are reclassifi ed to current-period earnings. As of
June 30, 2008, these cash-fl ow hedges were highly effec-
tive, in all material respects.
As a matter of policy, we only enter into contracts with
counterparties that have at least an “A” (or equivalent)
credit rating. The counterparties to these contracts are
major fi nancial institutions. We do not have signifi cant
exposure to any one counterparty. Our exposure to credit
loss in the event of nonperformance by any of the
counterparties is limited to only the recognized, but not
realized, gains attributable to the contracts. Management
believes risk of default under these hedging contracts is
remote and in any event would not be material to the
consolidated financial results. The contracts have
varying maturities through the end of June 2009. Costs
associated with entering into such contracts have not
been material to our consolidated fi nancial results. We do
not utilize derivative fi nancial instruments for trading or
speculative purposes.
At June 30, 2008, we had foreign currency forward
contracts and option contracts in the amount of $1,229.0
million and $64.9 million, respectively. The foreign curren-
cies included in foreign currency forward contracts
(notional value stated in U.S. dollars) are principally the
Euro ($221.6 million), British pound ($220.7 million),
Swiss franc ($206.5 million), Canadian dollar ($130.0 mil-
lion), Australian dollar ($91.8 million), Russian ruble ($71.9
million) and Japanese yen ($64.4 million). The foreign cur-
rencies included in foreign currency option contracts
(notional value stated in U.S. dollars) are principally the
Canadian dollar ($36.8 million) and the South Korean
won ($23.1 million).
Interest Rate Risk Management
We enter into interest rate derivative contracts to manage
the exposure to fl uctuations of interest rates on our
funded indebtedness and anticipated issuance of debt for
periods consistent with the identifi ed exposures. All inter-
est rate derivative contracts are with large financial
institutions rated as strong investment grade by a major
rating agency.
We have interest rate swap agreements, with a notional
amount totaling $250.0 million, to effectively convert the
fi xed rate interest on our 2017 Senior Notes to variable
interest rates based on six-month LIBOR. The interest rate
swaps were designated as fair-value hedges. As of June
30, 2008, these fair-value hedges were highly effective, in
all material respects.
Market Risk
We use a value-at-risk model to assess the market risk of
our derivative financial instruments. Value-at-risk
represents the potential losses for an instrument or
portfolio from adverse changes in market factors for a
specifi ed time period and confi dence level. We estimate