Nike 2016 Annual Report Download - page 42

PART II
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 financial instruments to manage exposure
to fluctuations in the value of foreign currencies and interest rates. It is our
policy to utilize these financial instruments only where necessary to finance
our business and manage such exposures; we do not enter into these
transactions for trading or speculative purposes.
We are exposed to foreign currency fluctuations, primarily as a result of our
international sales, product sourcing and funding activities. Our foreign
exchange risk management program is intended to lessen both the positive
and negative effects of currency fluctuations on our consolidated results of
operations, financial position and cash flows. We use forward and option
contracts to hedge certain anticipated but not yet firmly committed
transactions as well as certain firm commitments and the related receivables
and payables, including third-party and intercompany transactions. We have,
in the past, and may in the future, also use forward or options 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. Where exposures are hedged, our program has the effect
of delaying the impact of exchange rate movements on our Consolidated
Financial Statements.
The timing for hedging exposures, as well as the type and duration of the
hedge instruments employed, are guided by our hedging policies and
determined based upon the nature of the exposure and prevailing market
conditions. Typically, the Company may enter into hedge contracts starting
up to 12 to 24 months in advance of the forecasted transaction and may
place incremental hedges up to 100% of the exposure by the time the
forecasted transaction occurs. The majority of derivatives outstanding as of
May 31, 2016 are designated as foreign currency cash flow hedges, primarily
for Euro/U.S. Dollar, British Pound/Euro and Japanese Yen/U.S. Dollar
currency pairs. 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 flows and to reduce
overall borrowing costs. To achieve these objectives, we maintain a mix of
commercial paper, bank loans, fixed-rate debt of varying maturities and have
entered into receive-fixed, pay-variable interest rate swaps for a portion of our
fixed-rate debt, as well as pay-fixed, receive-variable forward-starting interest
rate swaps for cash outflows of interest payments on future debt.
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
financial instruments are foreign currency forward contracts, foreign currency
option contracts, interest rate swaps, intercompany loans denominated in
non-functional currencies, fixed interest rate U.S. Dollar denominated debt
and fixed 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 financial instruments. The VaR model
estimates assume normal market conditions and a 95% confidence 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 adjust the potential loss in option
value for the estimated sensitivity (the “delta” and “gamma”) to changes in the
underlying currency rate. This calculation reflects the impact of foreign
currency rate fluctuations on the derivative instruments only and does not
include the impact of such rate fluctuations on non-functional currency
transactions (such as anticipated transactions, firm 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 financial instruments, derived using the VaR model, was
$109 million and $117 million at May 31, 2016 and 2015, respectively. The
VaR decreased year-over-year as a result of a decrease in the total notional
value of our foreign currency derivative portfolio at May 31, 2016. Such a
hypothetical loss in the 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 $209 million and $205
million during fiscal 2016 and fiscal 2015, respectively.
The instruments not included in the VaR are intercompany loans
denominated in non-functional currencies, fixed interest rate Japanese Yen
denominated debt, fixed 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. Therefore, we consider the interest rate and foreign
currency market risks associated with our non-functional currency
intercompany loans to be immaterial to our consolidated financial position,
results from operations and cash flows.
During the year ended May 31, 2016, we entered into a series of forward-
starting interest rate swap agreements. A forward-starting interest rate swap
is an agreement that effectively hedges the variability in future benchmark
interest payments attributable to changes in interest rates on the forecasted
issuance of fixed-rate debt. We entered into these forward-starting interest
rate swaps in order to lock in fixed interest rates on our forecasted issuance of
debt. These instruments were designated as cash flow hedges of the
variability in the expected cash outflows of interest payments on future debt
due to changes in benchmark interest rates.
Details of third-party debt and interest rate swaps are provided in the table
below. The table presents principal cash flows and related weighted average
interest rates by expected maturity dates.
NIKE, INC. 2016 Annual Report and Notice of Annual Meeting 95
FORM 10-K