The Gap 2010 Annual Report Download - page 40

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
We operate in foreign countries, which exposes us to market risk associated with foreign currency exchange rate
fluctuations. Our risk management policy is to hedge a significant portion of forecasted merchandise purchases
denominated primarily in U.S. dollars made by our international subsidiaries whose functional currencies are their
local currencies, forecasted intercompany royalty payments, and intercompany obligations that bear foreign
exchange risk using foreign exchange forward contracts. These contracts are entered into with large, reputable
financial institutions that are monitored for counterparty risk. The principal currencies hedged against changes in
the U.S. dollar are Euro, British pounds, Japanese yen, and Canadian dollars. Our use of derivative financial
instruments represents risk management; we do not enter into derivative financial contracts for trading purposes.
Additional information is presented in Item 8, Financial Statements and Supplementary Data, Note 6 of Notes to
Consolidated Financial Statements. Our derivative financial instruments are recorded in the Consolidated Balance
Sheets at fair value as of the balance sheet dates. As of January 29, 2011, we had foreign exchange forward
contracts outstanding to buy the notional amount of $1 billion, 54 million British pounds, and 3 billion
Japanese yen.
We may also use foreign exchange forward contracts to hedge the net assets of international subsidiaries to
offset the foreign currency translation and economic exposures related to our investment in the subsidiaries. At
January 29, 2011, we had foreign exchange forward contracts outstanding to hedge the net assets of our Japanese
subsidiary in the notional amount of 3 billion Japanese yen.
We have performed a sensitivity analysis as of January 29, 2011 based on a model that measures the impact of a
hypothetical 10 percent adverse change in the level of foreign currency exchange rates to U.S. dollars (with all other
variables held constant) on our underlying exposure, net of derivative financial instruments. The foreign currency
exchange rates used in the model were based on the spot rates in effect at January 29, 2011. The sensitivity analysis
indicated that a hypothetical 10 percent adverse movement in foreign currency exchange rates would have an
unfavorable impact on the underlying cash flow exposure, net of our foreign exchange derivative financial
instruments, of $47 million at January 29, 2011.
We invest in fixed and variable income investments classified as cash and cash equivalents and short-term
investments. Our cash and cash equivalents and short-term investments are placed primarily in money market funds,
domestic commercial paper, U.S. treasury bills, and bank deposits, and are classified as held-to-maturity based on our
positive intent and ability to hold the securities to maturity. These investments are stated at amortized cost, which
approximates market value due to the short maturities. An increase in interest rates of 10 percent would not have a
material impact on the value of these investments. However, changes in interest rates would impact the interest
income derived from our investments. We earned interest income of $6 million in fiscal 2010.
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