eTrade 2002 Annual Report Download - page 177

Table of Contents
Index to Financial Statements
28. ACCOUNTING FOR DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
The Company enters into derivative transactions to protect against the risk of market price or interest rate movements on the value of certain
assets and future cash flows. The Company is also required to recognize certain contracts and commitments as derivatives when the
characteristics of those contracts and commitments meet the definition of a derivative as promulgated by SFAS No. 133.
Credit risk is the risk that a counterparty to a derivative contract fails to perform according to the terms of the agreement. Credit risk is managed
by limiting activity to approved counterparties and setting aggregate exposure limits for each approved counterparty. The credit risk that results
from interest rate swaps and purchased options is represented by the fair value of contracts that have unrealized gains at the reporting date.
Conversely, we have certain derivative contracts with unrealized losses of $150.2 million at December 31, 2002. These agreements required the
Company to pledge approximately $115.2 million of its mortgage-backed and investment securities as collateral.
At December 31, 2002, the Company does not expect any counterparties to fail to perform. Counterparties to interest rate swaps and purchased
interest rate options for which the Company has net credit risk at December31, 2002 are as follows (in thousands):
Counterparty CreditRisk
Salomon Brothers $ 4,302
Lehman Brothers 2,867
Bank of America 2,031
Credit Suisse First Boston 2,015
Total $ 11,215
Interest Rate Risk
The Company uses derivatives to provide a cost- and capital-efficient way to manage its interest rate risk by modifying the repricing or maturity
characteristics of certain assets and liabilities and by locking in rates on certain forecasted issuances of liabilities. The primary derivative
instruments used include interest rate swaps, options on forward-starting interest rate swaps, caps and floors. The Company enters into interest
rate swap agreements to assume fixed-rate interest payments in exchange for variable market-indexed interest payments. Depending on the
hedge relationship, the effects of these swap agreements are to (a) convert adjustable rate liabilities to longer-term fixed rate liabilities, (b)
convert long-term fixed rate assets to shorter-term adjustable rate assets or (c) reduce the variability of future changes in interest rates on
forecasted issuances of liabilities.
Fair Value Hedges
The Company uses a combination of interest rate swaps, purchased options on forward starting swaps, caps and floors to offset its exposure to a
change in value of certain fixed rate assets. In calculating the effective portion of the fair value hedges under SFAS No. 133, the change in the
fair value of the derivative is recognized currently in earnings, as is the change in value of the hedged asset attributable to the risk being hedged.
Accordingly, the net difference or hedge ineffectiveness, if any, is recognized currently in the consolidated statements of operations in other
income (expenses) as the fair value adjustments of financial derivatives. Fair value hedge ineffectiveness resulted in a loss for fiscal 2002 of
$22.4 million, $2.1 million for fiscal 2001 and $1.6million for the three months ended December 31, 2000.
During fiscal 2002, fiscal 2001 and the three months ended December 31, 2000, certain fair value hedges were derecognized and therefore
hedge accounting was discontinued during the period. Changes in the fair value of these derivative instruments after the discontinuance of fair
value hedge accounting are recorded in gains on
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2003. EDGAR Online, Inc.