McDonalds 2012 Annual Report Download - page 39

• Fair Value Hedges
The Company enters into fair value hedges to reduce the
exposure to changes in the fair values of certain liabilities. The
fair value hedges the Company enters into consist of interest rate
swaps which convert a portion of its fixed-rate debt into floating-
rate debt. All of the Company’s interest rate swaps meet the
shortcut method requirements. Accordingly, changes in the fair
values of the interest rate swaps are exactly offset by changes in
the fair value of the underlying debt. No ineffectiveness has been
recorded to net income related to interest rate swaps designated
as fair value hedges for the year ended December 31, 2012. A
total of $1.8 billion of the Company’s outstanding fixed-rate debt
was effectively converted to floating-rate debt resulting from the
use of interest rate swaps.
• Cash Flow Hedges
The Company enters into cash flow hedges to reduce the
exposure to variability in certain expected future cash flows. The
types of cash flow hedges the Company enters into include
interest rate swaps, foreign currency forwards, foreign currency
options, cross currency swaps, and commodity forwards.
The Company periodically uses interest rate swaps to effec-
tively convert a portion of floating-rate debt, including forecasted
debt issuances, into fixed-rate debt and the agreements are
intended to reduce the impact of interest rate changes on future
interest expense.
To protect against the reduction in value of forecasted foreign
currency cash flows (such as royalties denominated in foreign
currencies), the Company uses foreign currency forwards and
foreign currency options to hedge a portion of anticipated
exposures.
When the U.S. dollar strengthens against foreign currencies,
the decline in value of future foreign denominated royalties is
offset by gains in the fair value of the foreign currency forwards
and/or foreign currency options. Conversely, when the U.S. dollar
weakens, the increase in the value of future foreign denominated
royalties is offset by losses in the fair value of the foreign cur-
rency forwards and/or foreign currency options.
Although the fair value changes in the foreign currency
options may fluctuate over the period of the contract, the
Company’s total loss on a foreign currency option is limited to the
upfront premium paid for the contract; however, the potential
gains on a foreign currency option are unlimited. In some sit-
uations, the Company uses foreign currency collars, which limit
the potential gains and lower the upfront premium paid, to protect
against currency movements.
The hedges cover the next 19 months for certain exposures
and are denominated in various currencies. As of December 31,
2012, the Company had derivatives outstanding with an equiv-
alent notional amount of $626.9 million that were used to hedge
a portion of forecasted foreign currency denominated royalties.
The Company excludes the time value of foreign currency
options from its effectiveness assessment on its cash flow hedg-
es. As a result, changes in the fair value of the derivatives due to
this component, as well as the ineffectiveness of the hedges, are
recognized in earnings currently. The effective portion of the
gains or losses on the derivatives is reported in the cash flow
hedging component of OCI in shareholders’ equity and
reclassified into earnings in the same period or periods in which
the hedged transaction affects earnings.
The Company uses cross-currency swaps to hedge the risk of
cash flows associated with certain foreign-currency denominated
debt, including forecasted interest payments, and has elected
cash flow hedge accounting. The hedges cover periods up to
59 months and have an equivalent notional amount of
$245.8 million.
The Company manages its exposure to the variability of cash
flows for energy-related transactions in certain markets by enter-
ing into commodity forwards and has elected cash flow hedge
accounting as appropriate. The hedges cover periods up to 22
years and have an equivalent notional amount of $493.8 million.
The Company recorded after tax adjustments to the cash flow
hedging component of accumulated OCI in shareholders’ equity.
The Company recorded a net increase of $30.6 million for the
year ended December 31, 2012 and a net decrease of
$10.4 million for the year ended December 31, 2011. Based on
interest rates and foreign exchange rates at December 31, 2012,
the $35.2 million in cumulative cash flow hedging gains, after tax,
at December 31, 2012, is not expected to have a significant
effect on earnings over the next 12 months.
• Net Investment Hedges
The Company primarily uses foreign currency denominated debt
(third party and intercompany) to hedge its investments in certain
foreign subsidiaries and affiliates. Realized and unrealized trans-
lation adjustments from these hedges are included in
shareholders’ equity in the foreign currency translation compo-
nent of OCI and offset translation adjustments on the underlying
net assets of foreign subsidiaries and affiliates, which also are
recorded in OCI. As of December 31, 2012, $7.7 billion of inter-
company foreign currency denominated debt, $4.0 billion of the
Company’s third party foreign currency denominated debt and
$528.6 million of derivatives were designated to hedge invest-
ments in certain foreign subsidiaries and affiliates.
• Credit Risk
The Company is exposed to credit-related losses in the event of
non-performance by the counterparties to its hedging instru-
ments. The counterparties to these agreements consist of a
diverse group of financial institutions and market participants.
The Company continually monitors its positions and the credit
ratings of its counterparties and adjusts positions as appropriate.
The Company did not have significant exposure to any individual
counterparty at December 31, 2012 and has master agreements
that contain netting arrangements. For financial reporting pur-
poses, the Company presents gross derivative balances in the
financial statements and supplementary data, even for counter-
parties subject to netting arrangements. Some of these
agreements also require each party to post collateral if credit
ratings fall below, or aggregate exposures exceed, certain con-
tractual limits. At December 31, 2012, neither the Company nor
its counterparties were required to post collateral on any
derivative position, other than on hedges of certain of the
Company’s supplemental benefit plan liabilities where its
counterparties were required to post collateral on their liability
positions.
INCOME TAX UNCERTAINTIES
The Company, like other multi-national companies, is regularly
audited by federal, state and foreign tax authorities, and tax
assessments may arise several years after tax returns have been
McDonald’s Corporation 2012 Annual Report 37