Prudential 2006 Annual Report Download - page 163

PRUDENTIAL FINANCIAL, INC.
Notes to Consolidated Financial Statements
18. FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)
The carrying amount approximates or equals fair value for the following instruments: fixed maturities classified as available
for sale, equity securities, short-term investments, cash and cash equivalents, restricted cash and securities, separate account assets
and liabilities, trading account assets supporting insurance liabilities, other trading account assets, broker-dealer related receivables
and payables, securities purchased under agreements to resell, securities sold under agreements to repurchase, cash collateral for
loaned securities, and securities sold but not yet purchased. The following table discloses the Company’s financial instruments
where the carrying amounts and fair values differ at December 31,
2006 2005
Carrying
Amount
Fair
Value
Carrying
Amount
Fair
Value
(in millions)
Fixed maturities, held to maturity ............................................. $ 3,469 $ 3,441 $ 3,249 $ 3,228
Commercial loans ......................................................... 25,739 26,143 24,441 25,095
Policy loans .............................................................. 8,887 9,837 8,370 9,440
Investment contracts ....................................................... 68,320 68,372 64,509 64,529
Short-term and long-term debt ............................................... 23,959 24,276 19,384 19,845
Bank customer liabilities .................................................... 903 903 503 503
19. DERIVATIVE INSTRUMENTS
Types of Derivative Instruments and Derivative Strategies used in a non- dealer or broker capacity
Interest rate swaps are used by the Company to manage interest rate exposures arising from mismatches between assets and
liabilities (including duration mismatches) and to hedge against changes in the value of assets it anticipates acquiring and other
anticipated transactions and commitments. Swaps may be specifically attributed to specific assets or liabilities or may be used on a
portfolio basis. Under interest rate swaps, the Company agrees with other parties to exchange, at specified intervals, the difference
between fixed rate and floating rate interest amounts calculated by reference to an agreed upon notional principal amount.
Generally, no cash is exchanged at the outset of the contract and no principal payments are made by either party. Cash is paid or
received based on the terms of the swap. These transactions are entered into pursuant to master agreements that provide for a single
net payment to be made by one counterparty at each due date.
Exchange-traded futures and options are used by the Company to reduce market risks from changes in interest rates, to alter
mismatches between the duration of assets in a portfolio and the duration of liabilities supported by those assets, and to hedge
against changes in the value of securities it owns or anticipates acquiring or selling. In exchange-traded futures transactions, the
Company agrees to purchase or sell a specified number of contracts, the values of which are determined by the values of designated
classes of securities, and to post variation margin on a daily basis in an amount equal to the difference in the daily market values of
those contracts. The Company enters into exchange-traded futures and options with regulated futures commissions merchants who
are members of a trading exchange.
Futures typically are used to hedge duration mismatches between assets and liabilities. Futures move substantially in value as
interest rates change and can be used to either modify or hedge existing interest rate risk.
Currency derivatives, including exchange-traded currency futures and options, currency forwards and currency swaps, are used
by the Company to reduce market risks from changes in currency exchange rates with respect to investments denominated in
foreign currencies that the Company either holds or intends to acquire or sell. The Company also uses currency forwards to hedge
the currency risk associated with net investments in foreign operations and anticipated earnings of its foreign operations.
Under currency forwards, the Company agrees with other parties to deliver a specified amount of an identified currency at a
specified future date. Typically, the price is agreed upon at the time of the contract and payment for such a contract is made at the
specified future date. As noted above, the Company uses currency forwards to mitigate the risk that unfavorable changes in
currency exchange rates will reduce U.S. dollar equivalent earnings generated by certain of its non-U.S. businesses, primarily its
international insurance and investment operations. The Company executes forward sales of the hedged currency in exchange for
U.S. dollars at a specified exchange rate. The maturities of these forwards correspond with the future periods in which the non-U.S.
earnings are expected to be generated. These earnings hedges do not qualify for hedge accounting.
Under currency swaps, the Company agrees with other parties to exchange, at specified intervals, the difference between one
currency and another at an exchange rate and calculated by reference to an agreed principal amount. Generally, the principal amount
PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT
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