GE 2005 Annual Report Download - page 130

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(130)
Net investment hedges
Net investment hedges consist of currency forwards and currency swaps that reduce our exposure to changes in
currency exchange rates on our investments in non-U.S. financial services subsidiaries. For qualifying net
investment hedges, changes in the intrinsic value of the derivative are recorded in equity. Amounts excluded from
the measure of effectiveness of net investment hedges are recognized in earnings in the period in which they arise.
Derivative gains included in equity amounted to $977 million and $867 million at December 31, 2005 and 2004,
respectively.
Derivatives not designated as hedges
We must meet specific criteria in order to apply any of the three forms of hedge accounting discussed above. For
example, hedge accounting is not permitted for hedged items that are marked to market through earnings. However,
we use derivatives to hedge exposures when it makes economic sense to do so, including circumstances in which the
hedging relationship does not qualify for hedge accounting, as described in the following paragraph. Derivatives that
do not qualify for hedge accounting are marked to market through earnings.
We use swaps, futures and option contracts, including caps, floors and collars, as economic hedges of
changes in interest rates, currency exchange rates and equity prices on certain types of assets and liabilities. We
sometimes use credit default swaps to hedge the credit risk of various counterparties with which we have entered
into loan or leasing arrangements. We occasionally obtain equity warrants as part of sourcing or financing
transactions. Although these instruments are considered to be derivatives, their economic risks are similar to, and
managed on the same basis as, risks of other equity instruments we hold.
Earnings effects of derivatives (Restated)
In the context of hedging relationships, “effectiveness” refers to the degree to which fair value changes in the
hedging instrument offset the corresponding expected earnings effects of the hedged item. At December 31, 2005,
approximately 46 percent of our total interest rate swaps were exempt from ongoing tests of their effectiveness as
hedges. For derivatives designated and qualifying as hedges but not qualifying for the assumption of effectiveness,
we use a variety of techniques to assess effectiveness and measure ineffectiveness, including cumulative dollar
offset and regression analysis, depending on which method was selected at inception of the respective hedge.
Certain elements of hedge positions may be excluded from the measure of effectiveness, for example, changes in the
value of purchased options attributable to volatility and passage of time.
The following table provides additional information about the earnings effects of derivatives.
PRE-TAX GAINS (LOSSES)
December 31 (In millions)
2005
(Restated)
2004
(Restated)
2003
(Restated)
CASH FLOW HEDGES
Ineffectiveness $(27) $ 20 $ (44 )
Amounts excluded from the measure of effectiveness 17 25
FAIR VALUE HEDGES
Ineffectiveness
4 11
Amounts excluded from the measure of effectiveness (8) 3