Prudential 2003 Annual Report Download - page 161

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PRUDENTIAL FINANCIAL, INC.
Notes to Consolidated Financial Statements
18. DERIVATIVE INSTRUMENTS (continued)
Credit derivatives are used by the Company to enhance the return on the Company’s investment portfolio by
providing comparable exposure to fixed income securities that might not be available in the primary market. Credit
derivatives are sold for a premium and are recorded at fair value.
Forward contracts are used by the Company to manage market risks relating to interest rates. The Company also
uses “to be announced” (TBA) forward contracts to gain exposure to the investment risk and return of mortgage-
backed securities. TBA transactions can help the Company to achieve better diversification and to enhance the return
on its investment portfolio. TBAs provide a more liquid and cost effective method of achieving these goals than
purchasing or selling individual mortgage-backed pools. Typically, the price is agreed upon at the time of the contract
and payment for such a contract is made at a specified future date. A portion of this activity was exited in connection
with the restructuring of Prudential Securities Group Inc.’s capital markets activities.
Cash Flow, Fair Value and Net Investment Hedges
The ineffective portion of derivatives accounted for using hedge accounting in the years ended December 31,
2003, 2002 and 2001 was not material to the results of operations of the Company. In addition, there were no instances
in which the Company discontinued cash flow hedge accounting because the forecasted transaction did not occur on
the anticipated date or within the additional time period permitted by SFAS No. 133.
Presented below is a roll forward of current period cash flow hedges in “Accumulated other comprehensive
income (loss)” before taxes:
(in millions)
Additions due to cumulative effect of change in accounting principle upon adoption of SFAS No. 133 at
January 1, 2001 ................................................................................. $ 9
Net deferred losses on cash flow hedges from January 1 to December 31, 2001 ................................. (1)
Amount reclassified into current period earnings ......................................................... (24)
Balance, December 31, 2001 ........................................................................ (16)
Net deferred gains on cash flow hedges from January 1 to December 31, 2002 ................................. 40
Amount reclassified into current period earnings ......................................................... (27)
Balance, December 31, 2002 ........................................................................ (3)
Net deferred losses on cash flow hedges from January 1 to December 31, 2003 ................................. (90)
Amount reclassified into current period earnings ......................................................... (18)
Balance, December 31, 2003 ........................................................................ $(111)
It is anticipated that a pre-tax gain of approximately $5 million will be reclassified from “Accumulated other
comprehensive income (loss)” to earnings during the year ended December 31, 2004, offset by amounts pertaining to
the hedged items. The maximum length for which variable cash flows are hedged is 20 years. Income amounts deferred
in “Accumulated other comprehensive income (loss)” as a result of cash flow hedges are included in “Net unrealized
investment gains (losses)” in the Consolidated Statements of Stockholders’ Equity.
For effective net investment hedges, the amounts, before applicable taxes, recorded in the cumulative translation
adjustments account within “Accumulated other comprehensive income (loss)” were losses of $84 million in 2003,
losses of $67 million in 2002 and gains of $77 million in 2001.
For the years ended December 31, 2003, 2002 and 2001, there were no derivative reclassifications to earnings due
to hedged firm commitments no longer deemed probable or due to hedged forecasted transactions that had not occurred
by the end of the originally specified time period.
Prudential Financial 2003 Annual Report 159