Apple 2004 Annual Report Download - page 61

and short-term investments with its fixed-rate interest expense on its debt, and/or to diversify a portion of the Company's exposure away from
fluctuations in short-term U.S. interest rates. The Company did not enter into any interest rate derivatives during 2004 or 2003 and had no open
interest rate derivatives at September 25, 2004.
In prior years, the Company had entered into interest rate debt swaps with financial institutions. The interest rate debt swaps 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.
Due to prevailing market interest rates, during 2001 and 2002 the Company entered into and then subsequently closed out interest rate debt swap
positions realizing gains of $23 million. The gains were deferred, recognized in long-term debt and were amortized to other income and expense
over the remaining life of the debt.
Foreign Currency Risk
In general, the Company is a net receiver of currencies other than the U.S. dollar. 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 due to competitive pressures when there has been significant volatility
in foreign currency exchange rates.
The Company may enter into foreign currency forward and option contracts with financial institutions to protect against foreign exchange risks
associated with existing assets and liabilities, certain firmly committed transactions, forecasted future cash flows, and net investments in foreign
subsidiaries. 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 hedging instruments.
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 VAR 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 assumes
normal market conditions. Forecasted transactions, firm commitments, and assets and liabilities denominated in foreign currencies were
excluded from the model. Based on the results of the model, the Company estimates with 95% confidence a maximum one-day loss in fair value
of $3.2 million as of September 25, 2004 compared to a maximum one-day loss of $7.5
million as of September 27, 2003. Because the Company
uses foreign currency instruments for hedging purposes, losses incurred on those instruments are generally offset by increases in the fair value of
the underlying exposures.
Actual gains and losses in the future associated with the Company's investment portfolio and derivative positions may differ materially from the
sensitivity analyses performed as of September 25, 2004 due to the inherent limitations associated with predicting the changes in the timing and
amount of interest rates, foreign currency exchanges rates, and the Company's actual exposures and positions.
58