Siemens 2005 Annual Report Download - page 198

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Interest rate risk management
Interest rate risk arises from the sensitivity of financial assets and liabilities to changes in market
rates of interest. The Company seeks to mitigate such risk by entering into interest rate derivative
financial instruments such as interest rate swaps, options and, to a lesser extent, cross-currency
interest rate swaps and interest rate futures.
Interest rate swap agreements are used to adjust the proportion of total debt, and to a lesser
extent interest-bearing investments, that are subject to variable and fixed interest rates. Under an
interest rate swap agreement, the Company either agrees to pay an amount equal to a specified
variable rate of interest times a notional principal amount, and to receive in return an amount
equal to a specified fixed rate of interest times the same notional principal amount or, vice-versa,
to receive a variable-rate amount and to pay a fixed-rate amount. The notional amounts of the
contracts are not exchanged. No other cash payments are made unless the agreement is termi-
nated prior to maturity, in which case the amount paid or received in settlement is established
by agreement at the time of termination, and usually represents the net present value, at current
rates of interest, of the remaining obligations to exchange payments under the terms of the
contract.
Derivative financial instruments not designated as hedges
The Company uses a portfolio-based approach to manage its interest rate risk associated with
certain interest-bearing assets and liabilities, primarily interest-bearing investments and debt
obligations. This approach focuses on mismatches in the structure of the interest terms of these
assets and liabilities without referring to specific assets or liabilities. Such a strategy does not
qualify for hedge accounting treatment under SFAS 133. Accordingly, all interest rate derivative
instruments used in this strategy are recorded at fair value as either an Other current asset or
Other current liability and changes in the fair values are charged to earnings.
Fair value hedges of fixed-rate debt obligations
Under the interest rate swap agreements outstanding during the years ended September 30, 2005
and 2004, the Company agrees to pay a variable rate of interest multiplied by a notional principle
amount, and receive in return an amount equal to a specified fixed rate of interest multiplied by
the same notional principal amount. These interest rate swap agreements offset an impact of
future changes in interest rates on the fair value of the underlying fixed-rate debt obligations.
The interest rate swap contracts are reflected at fair value in the Company’s Consolidated Balance
Sheet and the related portion of fixed-rate debt being hedged is reflected at an amount equal to
the sum of its carrying amount plus an adjustment representing the change in fair value of the
debt obligations attributable to the interest rate risk being hedged. Changes in the fair value of
interest rates swap contracts, and the offsetting changes in the adjusted carrying amount of the
related portion of fixed-rate debt being hedged, are recognized as adjustments to the line item
Income (expense) from financial assets and marketable securities, net in the Consolidated State-
ments of Income. Net cash receipts and payments relating to such interest rate swap agreements
are recorded to interest expense.
Management’s discussion and analysis