American Express 2001 Annual Report Download - page 36

axp_34
FINANCIAL REVIEW
TRS’ Argentine card business is a small part of its global card operations. In December 2001 and January 2002, the Argentine
government mandated the conversion of dollar denominated assets into pesos and simultaneously devalued the peso. This develop-
ment has created a foreign exchange translation exposure that previously did not exist with respect to TRS’Argentine operations. The
devaluation has been given effect in the financial statements as of December 31, 2001 by recording a loss of $49 million in “foreign
currency translation adjustments” in the shareholders’ equity section of the consolidated balance sheet. TRS is taking steps to man-
age this risk to the extent practicable and efficient. The effect of the devaluation on the 2001 results of operations was immaterial.
AEFA’s owned investment securities are, for the most part, held by its life insurance and investment certificate subsidiaries, which
primarily invest in long-term and intermediate-term fixed income securities to provide their clients with a competitive rate of
return on their investments while controlling risk. Investment in fixed income securities is designed to provide AEFA with a tar-
geted margin between the interest rate earned on investments and the interest rate credited to clients’ accounts. AEFA does not
invest in securities to generate trading profits for its own account.
AEFA’s life insurance and investment certificate subsidiaries’ investment committees regularly review models projecting various
interest rate scenarios and risk/return measures and their effect on the profitability of each subsidiary. The committees’objectives
are to structure their investment security portfolios based upon the type and behavior of the products in the liability portfolios to
achieve targeted levels of profitability within defined risk parameters and to meet contractual obligations.
Rates credited to customers’ accounts are generally reset at shorter intervals than the maturity of underlying investments. There-
fore, AEFA’s margins may be affected by changes in the general level of interest rates. Part of the committees’ strategies include the
use of derivatives, such as interest rate caps, swaps and floors, for risk management purposes.
AEFA’s fees earned on the management of fixed income securities in variable annuities, variable insurance and mutual funds are
generally based on the value of the portfolios.
The negative effect on AEFA’s pretax earnings of a 100 basis point increase in interest rates, which assumes repricings and cus-
tomer behavior based on the application of proprietary models, to the book of business at December 31, 2001 and 2000, would be
approximately $35 million and $44 million for 2001 and 2000, respectively.
AEFA’s fees earned on the management of equity securities in variable annuities, variable insurance, mutual funds and other man-
aged assets are generally based on the value of the portfolios. AEFA writes and purchases index options to manage the margin
related to certain investment certificate and annuity products that pay interest based upon the relative change in a major stock mar-
ket index between the beginning and end of the product’s term. The negative effect on AEFA’s pretax earnings of a 10 percent
decline in equity markets would be approximately $81 million and $99 million based on assets under management, certificate and
annuity business in-force, and index options as of December 31, 2001 and 2000, respectively.
AEB employs a variety of financial instruments in managing its exposure to fluctuations in interest and currency rates. Derivative
instruments consist principally of foreign exchange spot and forward contracts, foreign currency options, interest rate swaps,
futures, and forward rate agreements. Generally, they are used to manage specific interest rate and foreign exchange exposures
related to deposits, long-term debt, equity, loans and securities holdings.
The negative effect of a 100 basis point increase in interest rates on AEB’s pretax earnings would be $18 million and $16 million
as of December 31, 2001 and 2000, respectively. The effect on earnings of a 10 percent strengthening of the U.S. dollar would be
negligible and, with respect to translation exposure of foreign operations, would result in an $11 million and $10 million pretax
charge against equity as of December 31, 2001 and 2000, respectively.
AEB utilizes foreign exchange and interest rate products to meet the needs of its customers. Customer positions are usually, but
not always, offset. They are evaluated in terms of AEB’s overall interest rate or foreign exchange exposure. AEB also takes limited
proprietary positions. Potential daily exposure from trading activities is calculated using a Value at Risk methodology. This model
employs a parametric technique using a correlation matrix based on historical data. The Value at Risk measure uses a 99 percent
confidence interval to estimate potential trading losses over a one-day period. At December 31, 2001 and 2000, the Value at Risk
for AEB was less than $1 million.