Estee Lauder 2009 Annual Report Download - page 111

110 THE EST{E LAUDER COMPANIES INC.
transactions have been designated as foreign currency
cash-fl ow hedges and have varying maturities through the
end of June 2010. Hedge effectiveness of foreign currency
forward contracts is based on a hypothetical derivative
methodology and excludes the portion of fair value attrib-
utable 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 meth-
odology. The ineffective portion of both foreign currency
forward and option contracts is recorded in current-period
earnings. For hedge contracts that are no longer deemed
highly effective, hedge accounting is discontinued and
gains and losses accumulated in other comprehensive
income (loss) are reclassifi ed to earnings when the under-
lying forecasted transaction occurs. If it is probable that
the forecasted transaction will no longer occur, then any
gains or losses in accumulated other comprehensive
income (loss) are reclassifi ed to current-period earnings.
As of June 30, 2009, these foreign currency cash-fl ow
hedges were highly effective, in all material respects.
At June 30, 2009, we had foreign currency forward
contracts in the amount of $1,260.8 million. The foreign
currencies included in foreign currency forward contracts
(notional value stated in U.S. dollars) are principally the
British pound ($239.1 million), Euro ($212.5 million), Swiss
franc ($206.8 million), Canadian dollar ($168.0 million),
Hong Kong dollar ($79.4 million), Japanese yen ($76.0
million) and Australian dollar ($69.6 million).
Interest Rate Risk Management
We enter into interest rate derivative contracts to manage
the exposure to interest rate fl uctuations on our funded
indebtedness and anticipated issuance of debt for periods
consistent with the identifi ed exposures. We have interest
rate swap agreements, with a notional amount totaling
$250.0 million, to effectively convert the fi xed rate inter-
est on our 2017 Senior Notes to variable interest rates
based on six-month LIBOR. These interest rate swap
agreements are designated as fair value hedges of the
related long-term debt and meet the accounting criteria
that permit changes in the fair values of the interest rate
swap agreements to exactly offset changes in the fair
value of the underlying long-term debt. As of June 30,
2009, these fair-value hedges were highly effective in all
material respects.
Credit Risk
As a matter of policy, we only enter into derivative
contracts with counterparties that have at least an “A”
(or equivalent) credit rating. The counterparties to these
contracts are major fi nancial institutions. Exposure to
credit risk in the event of nonperformance by any of the
counterparties is limited to the gross fair value of contracts
Derivative Financial Instruments and
Hedging Activities
We address certain fi nancial exposures through a con-
trolled program of risk management that includes the use
of derivative fi nancial instruments. We primarily enter into
foreign currency forward and option contracts to reduce
the effects of fl uctuating foreign currency exchange rates
and interest rate derivatives to manage the effects of inter-
est rate movements on our aggregate liability portfolio.
We also enter into foreign currency forward and option
contracts, not designated as hedging instruments, to
mitigate the change in fair value of specifi c assets and
liabilities on the balance sheet. We do not utilize deriva-
tive financial instruments for trading or speculative
purposes. Costs associated with entering into these
derivative fi nancial instruments have not been material to
our consolidated fi nancial results.
For each derivative contract entered into where we
look to obtain special hedge accounting treatment, we
formally document all relationships between hedging
instruments and hedged items, as well as our risk-manage-
ment objective and strategy for undertaking the hedge
transaction, the nature of the risk being hedged, how the
hedging instruments’ effectiveness in offsetting the
hedged risk will be assessed prospectively and retrospec-
tively, and a description of the method of measuring
ineffectiveness. This process includes linking all deriva-
tives to specifi c assets and liabilities on the balance sheet
or to specific firm commitments or forecasted trans-
actions. We also formally assess, both at the hedge’s
inception and on an ongoing basis, whether the deriva-
tives that are used in hedging transactions are highly
effective in offsetting changes in fair values or cash fl ows
of hedged items. If it is determined that a derivative is not
highly effective, or that it has ceased to be a highly effec-
tive hedge, 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 con-
sistent with our identifi ed exposures. The purpose of the
hedging activities is to minimize the effect of foreign
exchange rate movements on costs and on the cash fl ows
that we receive from foreign subsidiaries. The majority of
foreign currency forward contracts are denominated in
currencies of major industrial countries. We also enter
into foreign currency option contracts to hedge antici-
pated transactions where there is a high probability that
anticipated exposures will materialize. The foreign cur-
rency forward contracts entered into to hedge anticipated