American Express 2002 Annual Report Download - page 73

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I71 AXP INOTES TO CONSOLIDATED FINANCIAL STATEMENTS
that arises from short-term funding. AEFA uses interest rate products to hedge the risk of rising interest rates on investment
certificates which reset at shorter intervals than the average maturity of the investment portfolio.
During 2002 and 2001, the company reclassified into earnings pretax losses of $572 million and $660 million, respectively.
At December 31, 2002, the company expects to reclassify $571 million of net pretax losses on derivative instruments from
accumulated other comprehensive income (loss) to earnings during the next twelve months. These losses will be recognized in
earnings during the terms of those derivatives contracts at the same time that the company realizes the benefits of lower market
rates of interest on its funding of charge card and fixed rate lending products.
Currently, the longest period of time over which the company is hedging exposure to the variability in future cash flows is
5.3 years and relates to funding of foreign currency denominated receivables. The amounts of gains and losses reclassified into
earnings as a result of the discontinuance of cash flow hedges were not significant during either 2002 or 2001.
Fair Value Hedges
In addition to the fair value hedge discussed in Note 7, the company also uses interest rate swaps to hedge its firm commitments
to transfer, at a fixed rate, receivables to trusts established in connection with its asset securitizations. AEFA is exposed to inter-
est rate risk associated with its fixed rate corporate bond investments. AEFA enters into interest rate swaps to hedge the risk of
changing interest rates as investment certificates reset at shorter intervals than the average maturity of the investment portfolio.
The company uses derivatives to hedge against the change in fair value of some of its investments in public companies. Changes
in the fair value of the derivatives are recorded in earnings along with related designated changes in the spot price of the under-
lying shares. Changes in the time value elements of these derivatives are considered as hedge ineffectiveness.
During 2002 and 2001, the company recognized pretax net losses of $1.4 million and $1.2 million, respectively, primarily related
to the time value element of its fair value hedging instruments. This amount is included in other expenses in the Consolidated
Statements of Income. During the years ending December 31, 2002 and 2001, the company recognized immaterial amounts of
net gains or losses related to the ineffective portion of its fair value hedging instruments.
Hedges of Net Investment in Foreign Operations
The company designates foreign currency derivatives as hedges of net investments in certain foreign operations. For these
hedges unrealized gains and losses are recorded in the cumulative translation adjustment account included in other comprehen-
sive income (loss), whereas the related amounts due to or from counterparties are included in other liabilities or other assets.
For the years ended December 31, 2002 and 2001, the net amount of losses included in the cumulative translation adjustment
was not significant.
Derivatives Not Designated as Hedges
The company has economic hedges that either do not qualify or are not designated for hedge accounting treatment under SFAS
No. 133. In addition, American Express Bank (AEB) enters into derivative contracts both to meet the needs of its clients and, to
a limited extent, for trading purposes, including taking proprietary positions.
❙Foreign currency transaction exposures are economically hedged, where practical, through foreign currency contracts.
Foreign currency contracts involve the purchase and sale of a designated currency at an agreed upon rate for settlement on a
specified date. Such foreign currency forward contracts entered into by the company generally mature within one year. In
addition, for selected major overseas markets, the company uses foreign currency forward contracts with maturities not
exceeding fifteen months to offset the effect of changes in foreign currency exchange rates on future operating results.
❙AEFA uses interest rate caps, swaps and floors to protect the margin between the interest rates earned on investments and the
interest rates credited to holders of certain investment certificates and fixed annuities.
❙Certain of AEFA’s annuity and investment certificate products have returns tied to the performance of equity markets. These
elements are considered derivatives under SFAS No. 133. AEFA manages this equity market risk by entering into options and
futures with offsetting characteristics.
❙Certain of the company’s equity investments are in the form of warrants. Some of these warrants are deemed to be derivative
financial instruments.