Northrop Grumman 2009 Annual Report Download - page 91

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Derivative Financial Instruments and Hedging Activities – The company utilizes derivative financial instruments in
order to manage exposure to interest rate risk and foreign currency exchange rate risk. The company does not
use derivative financial instruments for trading or speculative purposes, nor does it use leveraged financial
instruments. Interest rate swap agreements utilize floating interest rates as an offset to the fixed-rate characteristics
of certain long-term debt instruments. Foreign currency forward contracts are used to manage foreign currency
exchange rate risk related to receipts from customers and payments to suppliers denominated in foreign
currencies.
Derivative financial instruments are recognized as assets or liabilities in the financial statements and measured at
fair value, substantially all of which are based on model-derived valuations whose inputs are observable and thus
considered Level 2 inputs. Changes in the fair value of derivative financial instruments that qualify and are
designated as fair value hedges are recorded in earnings from continuing operations, while the effective portion
of the changes in the fair value of derivative financial instruments that qualify and are designated as cash flow
hedges are recorded in other comprehensive income. Credit risk related to derivative financial instruments is
considered minimal and is managed by requiring high credit standards for counterparties and periodic settlements
of the underlying transactions.
For derivative financial instruments not designated as hedging instruments as well as the ineffective portion of cash
flow hedges, gains or losses resulting from changes in the fair value are reported in Other, net in the consolidated
statements of operations. Unrealized gains or losses on cash flow hedges are reclassified from other comprehensive
income to earnings from continuing operations upon the recognition of the underlying transactions.
As of December 31, 2009, an interest rate swap with a notional value of $200 million, and foreign currency
purchase and sale forward contract agreements with notional values of $77 million and $151 million, respectively,
were designated as hedging instruments. The remaining notional values outstanding at December 31, 2009,
under foreign currency purchase and sale forward contracts of $19 million and $74 million, respectively, were not
designated as hedging instruments.
As of December 31, 2008, interest rate swaps with notional values totaling $400 million, and foreign currency
purchase and sale forward contract agreements with notional values of $74 million and $210 million, respectively,
were designated as hedging instruments. The remaining notional values outstanding at December 31, 2008,
under foreign currency purchase and sale forward contracts of $56 million and $82 million, respectively, were not
designated as hedging instruments.
In October 2008, the company entered into two forward-starting interest rate swaps with a notional value
totaling $400 million and designated these swaps as cash flow hedges. The fair value of the forward-starting swap
agreements was a $58 million liability at December 31, 2008, and was included in other current liabilities. These
swaps were settled as of June 8, 2009, and the related impact on the consolidated statements of operations was
not material. All other derivative fair values and related unrealized gains and losses at December 31, 2009, and
2008, were not material.
The carrying amounts of other financial instruments not listed in the table below approximate fair value due to
the short-term nature of these items. Carrying amounts and the related estimated fair values of the company’s
financial instruments not recorded at fair value in the financial statements are as follows:
$ in millions
Carrying
Amount
Fair
Value
Carrying
Amount
Fair
Value
2009 2008
Cash surrender value of life insurance policies $ 242 $ 242 $ 240 $ 240
Long-term debt (4,282) (4,825) (3,920) (4,369)
Cash Surrender Value of Life Insurance Policies – The company maintains variable universal life insurance policies on a group
of executives which are recorded at their cash surrender value as determined by the insurance carrier. Additionally, the
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NORTHROP GRUMMAN CORPORATION
eBP - v54508-i003_a.pdf - Page 85 of 124 - March 11, 2010 - 20:02:40