Apple 2002 Annual Report Download - page 37

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investment portfolio, the Company may sell investments prior to their stated maturities. As a result of such activity, the Company recognized
net gains of $7 million in 2002 and $1 million in 2001.
In order to provide a meaningful assessment of the interest rate risk associated with the Company's investment portfolio, the Company
performed a sensitivity analysis to determine the impact that a change in interest rates would have on the value of the investment portfolio
assuming a 100 basis point parallel shift in the yield curve. Based on investment positions as of September 28, 2002, a hypothetical 100 basis
point increase in interest rates across all maturities would result in a $37.7 million decline in the fair market value of the portfolio. As of
September 29, 2001, a similar 100 basis point shift in the yield curve would have resulted in a $17.8 million decline in fair value. Such losses
would only be realized if the Company sold the investments prior to maturity. Except in instances noted above, the Company's policy is to hold
investments to maturity.
The Company sometimes enters into interest rate derivative transactions, including interest rate swaps, collars, and floors, with financial
institutions in order to better match the Company's floating-rate interest income on its cash equivalents and short-term investments with its
fixed-rate interest expense on its long-term debt, and/or to diversify a portion of the Company's exposure away from fluctuations in short-term
U.S. interest rates. The Company may also enter into interest rate contracts that are intended to reduce the cost of the interest rate risk
management program.
During the last two years, the Company has entered into interest rate swaps with financial institutions in order to better match the Company's
floating-rate interest income on its cash equivalents and short-term investments with its fixed-rate interest expense on its long-
term debt, and/or
to diversify a portion of the Company's exposure away from fluctuations in short-term U.S. interest rates. The interest rate swaps, which
qualified as accounting hedges, generally required the Company to pay a floating interest rate based on the three- or six-month U.S. dollar
LIBOR and receive a fixed rate of interest without exchanges of the underlying notional amounts. These swaps effectively converted the
Company's fixed-rate 10-year debt to floating-rate debt and convert a portion of the floating rate investments to fixed rate. Due to prevailing
market interest rates, during 2002 the Company entered into and then subsequently closed out debt swap positions realizing a gain of
$6 million. During 2001 the Company closed out all of its then existing debt swap positions realizing a gain of $17 million. Both the gains in
2001 and 2002 were deferred, recognized in long-term debt and are being amortized to other income and expense over the remaining life of the
debt. At certain times in the past, the Company has also entered into interest rate contracts that are intended to reduce the cost of the interest
rate risk management program. The Company does not hold or transact in such financial instruments for purposes other than risk management.
The Company's asset swaps did not qualify for hedge accounting treatment and were recorded at fair value on the balance sheet with associated
gains and losses recorded in interest and other income. Interest rate asset swaps outstanding as of September 30, 2000, had a weighted-average
receive rate of 5.50% and a weighted-average pay rate of 6.66%. The unrealized loss on these assets swaps as of September 30, 2000, of
$5.7 million was deferred and then recognized in income in 2001 as part of the SFAS No. 133 transition adjustment effective on October 1,
2000. The Company closed out all of its existing interest rate asset swaps during 2001 realizing a gain of $1.1 million.
Foreign Currency Risk
Overall, the Company is a net receiver of currencies other than the U.S. dollar and, as such, benefits from a weaker dollar and is adversely
affected by a stronger dollar relative to major currencies worldwide. Accordingly, changes in exchange rates, and in particular a strengthening
of the U.S. dollar, may negatively affect the Company's net sales and gross margins as expressed in U.S. dollars. There is also a risk that the
Company will have to adjust local currency product pricing within the time frame of our hedged positions due to competitive pressures when
there has been significant volatility in foreign currency exchange rates.
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The Company enters into foreign currency forward and option contracts with financial institutions primarily to protect against foreign exchange
risks associated with existing assets and liabilities, certain firmly committed transactions, and probable but not firmly committed transactions.
Generally, the Company's practice is to hedge a majority of its existing material foreign exchange transaction exposures. However, the
Company may not hedge certain foreign exchange transaction exposures due to immateriality, prohibitive economic cost of hedging particular
exposures, and limited availability of appropriate of hedging instruments. The Company also enters into foreign currency forward and option
contracts to offset the foreign exchange gains and losses generated by the re-
measurement of certain recorded assets and liabilities denominated
in non-functional currencies of its foreign subsidiaries.
In order to provide a meaningful assessment of the foreign currency risk associated with certain of the Company's foreign currency derivative
positions, the Company performed a sensitivity analysis using a value-at-risk (VAR) model to assess the potential impact of fluctuations in
exchange rates. The VAR model consisted of using a Monte Carlo simulation to generate 3000 random market price paths. The value-at-risk is
the maximum expected loss in fair value, for a given confidence interval, to the Company's foreign exchange portfolio due to adverse
movements in rates. The VAR model is not intended to represent actual losses but is used as a risk estimation and management tool. The model