Nike 2011 Annual Report Download - page 32

32 NIKE,INC.-Form10-K
PARTII
ITEM7AQuantitative and Qualitative Disclosures about Market Risk
ITEM7A Quantitative and Qualitative Disclosures
about Market Risk
In the normal course of business and consistent with established policies
and procedures, we employ a variety of fi nancial instruments to manage
exposure to fl uctuations in the value of foreign currencies and interest rates.
It is our policy to utilize these fi nancial instruments only where necessary to
fi nance our business and manage such exposures; we do not enter into these
transactions for speculative purposes.
We are exposed to foreign currency fl uctuations, primarily as a result of
our international sales, product sourcing and funding activities. Our foreign
exchange risk management program is intended to minimize both the positive
or negative effects of currency fl uctuations on our consolidated results of
operations, fi nancial position and cash fl ows. This also has the effect of delaying
the impact of current market rates on our consolidated fi nancial statements
dependent upon hedge horizons. We use forward exchange contracts and
options to hedge certain anticipated but not yet fi rmly committed transactions
as well as certain fi rm commitments and the related receivables and payables,
including third party and intercompany transactions. We also use forward
contracts to hedge our investment in the net assets of certain international
subsidiaries to offset foreign currency translation adjustments related to our
net investment in those subsidiaries.
When we begin hedging exposures, the type and duration of each hedge
depends on the nature of the exposure and market conditions. Generally,
all anticipated and fi rmly committed transactions that are hedged are to be
recognized within 12 to 18months. The majority of the contracts expiring
in more than 12months relate to the anticipated purchase of inventory.
Whenintercompany loans are hedged, it is typically for their expected duration.
Hedged transactions are principally denominated in Euros, Japanese Yen
and British Pounds. See Section“Foreign Currency Exposures and Hedging
Practices” under Item7 for additional detail.
Our earnings are also exposed to movements in short and long-term market
interest rates. Our objective in managing this interest rate exposure is to limit
the impact of interest rate changes on earnings and cash fl ows and to reduce
overall borrowing costs. To achieve these objectives, we maintain a mix of
commercial paper, bank loans and fi xed rate debt of varying maturities and
have entered into receive-fi xed, pay-variable interest rate swaps.
Market Risk Measurement
We monitor foreign exchange risk, interest rate risk and related derivatives
using a variety of techniques including a review of market value, sensitivity
analysis, and Value-at-Risk (“VaR”). Our market-sensitive derivative and other
fi nancial instruments are foreign currency forward contracts, foreign currency
option contracts, interest rate swaps, intercompany loans denominated in
non-functional currencies, fi xed interest rate U.S. dollar denominated debt,
and fi xed interest rate Japanese Yen denominated debt.
We use VaR to monitor the foreign exchange risk of our foreign currency forward
and foreign currency option derivative instruments only. The VaR determines
the maximum potential one-day loss in the fair value of these foreign exchange
rate-sensitive fi nancial instruments. The VaR model estimates assume normal
market conditions and a 95% confi dence level. There are various modeling
techniques that can be used in the VaR computation. Our computations are
based on interrelationships between currencies and interest rates (a“variance/
co-variance” technique). These interrelationships are a function of foreign
exchange currency market changes and interest rate changes over the preceding
oneyear period. The value of foreign currency options does not change on a
one-to-one basis with changes in the underlying currency rate. We adjusted
the potential loss in option value for the estimated sensitivity (the “delta” and
“gamma”) to changes in the underlying currency rate. This calculation refl ects
the impact of foreign currency rate fl uctuations on the derivative instruments
only and does not include the impact of such rate fl uctuations on non-functional
currency transactions (such as anticipated transactions, fi rm commitments,
cash balances, and accounts and loans receivable and payable), including
those which are hedged by these instruments.
The VaR model is a risk analysis tool and does not purport to represent
actual losses in fair value that we will incur, nor does it consider the potential
effect of favorable changes in market rates. It also does not represent the
full extent of the possible loss that may occur. Actual future gains and losses
will differ from those estimated because of changes or differences in market
rates and interrelationships, hedging instruments and hedge percentages,
timing and other factors.
The estimated maximum one-day loss in fair value on our foreign currency
sensitive derivative fi nancial instruments, derived using the VaR model, was
$33million and $17million at May31,2011 and 2010, respectively. The VaR
increasedyear-over-year primarily as a result of increased foreign currency
volatilities at May31,2011. Such a hypothetical loss in fair value of our derivatives
would be offset by increases in the value of the underlying transactions being
hedged. The averagemonthly change in the fair values of foreign currency
forward and foreign currency option derivative instruments was $79million
and $52million during fi scal2011 and fi scal2010, respectively.
The instruments not included in the VaR are intercompany loans denominated
in non-functional currencies, fi xed interest rate Japanese Yen denominated
debt, fi xed interest rate U.S. dollar denominated debt and interest rate swaps.
Intercompany loans and related interest amounts are eliminated in consolidation.
Furthermore, our non-functional currency intercompany loans are substantially
hedged against foreign exchange risk through the use of forward contracts,
which are included in the VaR calculation above. We, therefore, consider
the interest rate and foreign currency market risks associated with our non-
functional currency intercompany loans to be immaterial to our consolidated
fi nancial position, results from operations and cash fl ows.
Details of third party debt and interest rate swaps are provided in the table
below. The table presents principal cash fl ows and related weighted average
interest rates by expected maturity dates. Weighted average interest rates
for the fi xed rate swapped to fl oating rate debt refl ect the effective interest
rates as of May31,2011.