GE 2005 Annual Report Download - page 129

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(129)
To qualify for hedge accounting, details of the hedging relationship must be formally documented at
inception of the arrangement, including the risk management objective, hedging strategy, hedged item, specific risks
that are to be hedged, the derivative instrument and how effectiveness is being assessed. The derivative must be
highly effective in offsetting either changes in fair value or cash flows, as appropriate, for the risk being hedged.
Effectiveness is assessed at the inception of the relationship. If specified criteria for the assumption of effectiveness
are not met at hedge inception, effectiveness is assessed quarterly on a retrospective and prospective basis.
Ineffectiveness is also measured quarterly, with the results recognized in earnings.
For derivatives that are not exchange-traded instruments, we use internal valuation models that incorporate
market-based information. With the exception of foreign currency forwards and commodity derivatives, we also
obtain valuations from our derivative counterparties to validate the valuations produced by our own models and to
value a limited number of products that our internal models do not cover.
Cash flow hedges (Restated)
Our cash flow hedging arrangements use simple derivatives to offset the variability of expected future cash flows.
We use interest rate and currency swaps to convert variable rate borrowings to match the nature of the assets we
acquire. We use currency forwards and options to manage exposures to changes in currency exchange rates
associated with commercial purchase and sale transactions, including commodities. These instruments permit us to
reduce the cash flow variability, in local currency, of costs or selling prices denominated in currencies other than the
functional currency. For derivatives designated as cash flow hedges, we record changes in fair value in a separate
component of equity to the extent effective, then release those changes to earnings contemporaneously with the
earnings effects of the hedged items. If the hedge relationship is terminated, then the change in fair value of the
derivative recorded in equity is recognized contemporaneously with the earnings effects of the hedged item,
consistent with the original hedge strategy.
At December 31, 2005, amounts related to derivatives qualifying as cash flow hedges amounted to a
reduction of equity of $352 million, of which we expect to transfer $123 million to earnings in 2006 along with the
earnings effects of the related forecasted transactions. At that date, the maximum term of derivative instruments that
hedge forecasted transactions was 27 years and related to hedges of anticipated bond purchases. Funding for those
purchases is provided by contractual premiums on insurance policies of similar duration.
Fair value hedges
Fair value hedges are hedges that reduce the risk of changes in the fair values of assets, liabilities and certain types
of firm commitments. We use interest rate swaps, currency swaps and interest rate and currency forwards to hedge
the effects of interest rate and currency exchange rate changes on local and nonfunctional currency denominated
fixed-rate borrowings and certain types of fixed-rate assets. We record changes in fair value of a derivative
designated and effective as a fair value hedge in earnings, offset by corresponding changes in the fair value of the
hedged item.
Fair value adjustments decreased the carrying amount of debt outstanding at December 31, 2005, by $114
million.