Harman Kardon 2011 Annual Report Download - page 87

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Note 10 – Derivatives
We are exposed to market risk from changes in foreign currency exchange rates and interest rates, which
could affect our operating results, financial condition and cash flows. We manage our exposure to these risks
through our regular operating and financial activities and, when appropriate, through the use of derivative
financial instruments. These derivative instruments are utilized to hedge economic exposures, as well as to
reduce earnings and cash flow volatility resulting from shifts in market rates. We enter into limited types of
derivative contracts, including foreign currency spot, forward and option contracts and an interest rate swap, to
manage foreign currency and interest rate exposures. Our primary foreign currency exposure is the Euro. The fair
market values of all our derivative contracts change with fluctuations in interest rates and currency rates and are
designed so that any changes in their values are offset by changes in the values of the underlying
exposures. Derivative financial instruments are held solely as risk management tools and not for trading or
speculative purposes.
We record all derivative instruments as either assets or liabilities at fair value in our Consolidated Balance
Sheets. Certain of these derivative contracts have been designated as cash flow hedges, whereby gains and losses
are reported within AOCI in our Consolidated Balance Sheets, until the underlying transaction occurs, at which
point they are reported in earnings as gains and losses in our Consolidated Statements of Operations. Certain of
our derivatives, for which hedge accounting is not applied, are effective as economic hedges. These derivative
contracts are required to be recognized each period at fair value, with gains and losses reported in earnings in our
Consolidated Statements of Operations and therefore do result in some level of earnings volatility. The level of
volatility will vary with the type and amount of derivative hedges outstanding, as well as fluctuations in the
currency and interest rate markets during the period. The related cash flow impacts of all our derivative activities
are reflected as cash flows from operating activities.
Derivatives, by their nature, involve varying degrees of market and credit risk. The market risk associated
with these instruments resulting from currency exchange and interest rate movements is expected to offset the
market risk of the underlying transactions, assets and liabilities being hedged. We do not believe there is
significant risk of loss in the event of non-performance by the counterparties associated with these instruments,
because these transactions are executed with a diversified group of major financial institutions. Furthermore, our
policy is to contract only with counterparties having a minimum investment grade or better credit rating. Credit
risk is managed through the continuous monitoring of exposure to such counterparties.
Foreign Exchange Risk Management
We use foreign exchange contracts to hedge the price risk associated with foreign denominated forecasted
purchases of materials used in our manufacturing process and to manage currency risk associated with operating
costs in certain operating units, including foreign currency denominated intercompany loans and other foreign
currency denominated assets. These contracts generally mature in one year or less. A portion of these contracts
are designated as cash flow hedges.
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