HR Block 2010 Annual Report Download - page 49

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
GENERAL –We have a formal investment policy that strives to minimize the market risk exposure of our cash
equivalents and available-for-sale (AFS) securities, which are primarily affected by credit quality and movements
in interest rates. These guidelines focus on managing liquidity and preserving principal and earnings.
Our cash equivalents are primarily held for liquidity purposes and are comprised of high quality, short-term
investments, including qualified money market funds. Because our cash and cash equivalents have a relatively
short maturity, our portfolio’s market value is relatively insensitive to interest rate changes.
As our short-term borrowings are generally seasonal, interest rate risk typically increases through our third
fiscal quarter and declines to zero by fiscal year-end. While the market value of short-term borrowings is relatively
insensitive to interest rate changes, interest expense on short-term borrowings will increase and decrease with
changes in the underlying short-term interest rates.
Our long-term debt at April 30, 2010, consists primarily of fixed-rate Senior Notes; therefore, a change in interest
rates would have no impact on consolidated pretax earnings. See Item 8, note 10 to our consolidated financial
statements.
HRB BANK –At April 30, 2010, approximately 42% of HRB Bank’s total assets were residential mortgage loans
with 40% of these fixed-rate loans and 60% adjustable-rate loans. These loans are sensitive to changes in interest
rates as well as expected prepayment levels. As interest rates increase, fixed-rate residential mortgages tend to
exhibit lower prepayments. The opposite is true in a falling rate environment. When mortgage loans prepay,
mortgage origination costs are written off. Depending on the timing of the prepayment, the write-offs of mortgage
origination costs may result in lower than anticipated yields.
At April 30, 2010, HRB Bank’s other investments consisted primarily of mortgage-backed securities and FHLB
stock. See table below for sensitivity analysis of our mortgage-backed securities.
HRB Bank’s liabilities consist primarily of transactional deposit relationships, such as prepaid debit card
accounts and checking accounts. Other liabilities include money market accounts, certificates of deposit and
collateralized borrowings from the FHLB. Money market accounts re-price as interest rates change. Certificates of
deposit re-price over time depending on maturities. FHLB advances generally have fixed rates ranging from one
day through multiple years.
Under criteria published by the OTS, HRB Bank’s overall interest rate risk exposure at March 31, 2010, the most
recent date an evaluation was completed, was characterized as “minimal.” We actively manage our interest rate
risk positions. As interest rates change, we will adjust our strategy and mix of assets and liabilities to optimize our
position.
EQUITY PRICE RISK
We have limited exposure to the equity markets. Our primary exposure is through our deferred compensation
plans. Within the deferred compensation plans, we have mismatches in asset and liability amounts and investment
choices (both fixed-income and equity). At April 30, 2010 and 2009, the impact of a 10% market value change in the
combined equity assets held by our deferred compensation plans and other equity investments would be
approximately $9.7 million and $7.3 million, respectively, assuming no offset for the liabilities.
FOREIGN EXCHANGE RATE RISK
Our operations in international markets are exposed to movements in currency exchange rates. The currencies
involved are the Canadian dollar and the Australian dollar. We translate revenues and expenses related to these
operations at the average of exchange rates in effect during the period. Assets and liabilities of foreign subsidiaries
are translated into U.S. dollars at exchange rates prevailing at the end of the year. Translation adjustments are
recorded as a separate component of other comprehensive income in stockholders’ equity. Translation of financial
results into U.S. dollars does not presently materially affect and has not historically materially affected our
consolidated financial results, although such changes do affect the year-to-year comparability of the operating
results in U.S. dollars of our international businesses. We estimate a 10% change in foreign exchange rates by itself
would impact consolidated net income in fiscal years 2010 and 2009 by approximately $5.1 million and $3.0 million,
respectively, and cash balances at April 30, 2010 and 2009 by $7.1 million and $5.4 million, respectively.
During fiscal year 2010, borrowing needs in our Canadian operations were funded by corporate borrowings in
the U.S. To mitigate the foreign currency exchange rate risk, we used forward foreign exchange contracts. We do
not enter into forward contracts for speculative purposes. In estimating the fair value of derivative positions, we
utilized quoted market prices, if available, or quotes obtained from external sources. When foreign currency
financial instruments are outstanding, exposure to market risk on these instruments results from fluctuations in
H&R BLOCK 2010 Form 10K 33