Union Pacific 2011 Annual Report Download - page 42

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Market and Credit Risk – We address market risk related to derivative financial instruments by selecting
instruments with value fluctuations that highly correlate with the underlying hedged item. We manage
credit risk related to derivative financial instruments, which is minimal, by requiring high credit standards
for counterparties and periodic settlements. At December 31, 2011 and 2010, we were not required to
provide collateral, nor had we received collateral, relating to our hedging activities.
Determination of Fair Value – We determine the fair values of our derivative financial instrument
positions based upon current fair values as quoted by recognized dealers or the present value of
expected future cash flows.
Sensitivity Analyses – The sensitivity analyses that follow illustrate the economic effect that hypothetical
changes in interest rates could have on our results of operations and financial condition. These
hypothetical changes do not consider other factors that could impact actual results.
At December 31, 2011, we had variable-rate debt representing approximately 2.3% of our total debt. If
variable interest rates average one percentage point higher in 2012 than our December 31, 2011 variable
rate, which was approximately 1.2%, our interest expense would increase by approximately $2 million.
This amount was determined by considering the impact of the hypothetical interest rate on the balances
of our variable-rate debt at December 31, 2011.
Market risk for fixed-rate debt is estimated as the potential increase in fair value resulting from a
hypothetical one percentage point decrease in interest rates as of December 31, 2011, and amounts to
an increase of approximately $924 million to the fair value of our debt at December 31, 2011. We
estimated the fair values of our fixed-rate debt by considering the impact of the hypothetical interest rates
on quoted market prices and current borrowing rates.
Interest Rate Fair Value Hedges – We manage our overall exposure to fluctuations in interest rates by
adjusting the proportion of fixed and floating rate debt instruments within our debt portfolio over a given
period. We generally manage the mix of fixed and floating rate debt through the issuance of targeted
amounts of each as debt matures or as we require incremental borrowings. We employ derivatives,
primarily swaps, as one of the tools to obtain the targeted mix. In addition, we also obtain flexibility in
managing interest costs and the interest rate mix within our debt portfolio by evaluating the issuance of
and managing outstanding callable fixed-rate debt securities.
Swaps allow us to convert debt from fixed rates to variable rates and thereby hedge the risk of changes in
the debt’s fair value attributable to the changes in interest rates. We account for swaps as fair value
hedges using the short-cut method as allowed by the Derivatives and Hedging Topic of the FASB
Accounting Standards Codification (ASC); therefore, we do not record any ineffectiveness within our
Consolidated Financial Statements.
Interest Rate Cash Flow Hedges – We report changes in the fair value of cash flow hedges in
accumulated other comprehensive loss until the hedged item affects earnings. At December 31, 2011 and
2010, we recorded reductions of $2 million and $3 million, respectively, as an accumulated other
comprehensive loss that is being amortized on a straight-line basis through September 30, 2014. As of
December 31, 2011 and 2010, we had no interest rate cash flow hedges outstanding.
Recently Issued Accounting Pronouncements – In June 2011, the FASB issued Accounting Standards
Update No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income (ASU
2011-05). ASU 2011-05 will require companies to present the components of net income and other
comprehensive income either as one continuous statement or as two consecutive statements. It
eliminates the option to present components of other comprehensive income as part of the statement of
changes in stockholders' equity. The standard does not change the items which must be reported in other
comprehensive income, how such items are measured or when they must be reclassified to net income.
This standard is effective for interim and annual periods beginning after December 15, 2011. Because
this ASU impacts presentation only, it will have no effect on our financial condition, results of operations
or cash flows.
Asserted and Unasserted Claims – Various claims and lawsuits are pending against us and certain of
our subsidiaries. We cannot fully determine the effect of all asserted and unasserted claims on our
consolidated results of operations, financial condition, or liquidity; however, to the extent possible, where
asserted and unasserted claims are considered probable and where such claims can be reasonably