Sprint - Nextel 2006 Annual Report Download - page 117

Our foreign exchange risk management program focuses on reducing transaction exposure to optimize
consolidated cash flow. We enter into forward and option contracts in foreign currencies to reduce the impact
of changes in foreign exchange rates. Our primary transaction exposure results from net payments made to and
received from overseas communications companies for completing international calls made by our domestic
customers and the operations of our international subsidiaries.
Interest Rate Derivatives
As of December 31, 2006, we held fair value interest rate swaps with a notional value of $1.0 billion. These
swaps were entered into as hedges of the fair value of a portion of our senior notes and have maturities
ranging from 2008 to 2012. On a semiannual basis, we pay a floating rate of interest equal to the six-month
LIBOR plus a fixed spread and receive an average interest rate equal to the coupon rates stated on the
underlying senior notes.
Our interest rate swaps meet all the required criteria under SFAS No. 133, as amended, in order to apply the
shortcut method of accounting for these instruments, as all of the critical terms of the swaps perfectly match
the corresponding terms of the hedged debt. Under the shortcut method, we can assume that our interest rate
swaps are perfectly effective in hedging our interest rate risk. We recognize all changes in the fair values of
the interest rate swaps currently as a gain or loss within other income (expense) on the consolidated statements
of operations, in accordance with SFAS No. 133, as amended. Under the shortcut method, these changes in the
fair value of the hedging instrument are offset by an equal change in the fair value of the underlying debt,
with no impact on earnings.
Our interest rate swap activity generated a net liability of $25 million as of December 31, 2006 compared to a
net liability of $17 million as of December 31, 2005, resulting from changes in the fair value of the interest
rate swaps with an offset recorded to the underlying long-term debt.
During the fourth quarter 2005, we entered into a series of interest rate collars associated with the issuance of
debt by Embarq at the time of its spin-off on May 17, 2006. See note 2 for additional information. These
derivative instruments did not qualify for hedge accounting treatment in our consolidated financial statements,
and changes in the fair value of these instruments are recognized in earnings from discontinued operations
during the period of change. For 2005, the fair value of these derivatives decreased, resulting in a loss of
$12 million, after tax, as of December 31, 2005. During 2006, the fair value of these derivatives increased,
resulting in a $43 million gain, after tax. These derivatives were settled upon completion of the spin-off.
Equity Derivatives
In 2005, we entered into a series of option contracts associated with our investment in NII Holdings designed
to hedge our exposure to the risk of unfavorable changes in the price of NII Holdings’ common shares. The
first contract was written for 1.7 million common shares of NII Holdings and was not designated an effective
hedging instrument. Therefore, changes in the fair value of the derivative instrument were recognized in
earnings during the period of change prior to settlement. We settled the first option contract on March 31,
2006 in conjunction with the sale of 1.7 million common shares of NII Holdings. We recognized a gain of
about $37 million from the sale of the underlying shares, partially offset by a loss of about $23 million from
the change in fair value of the option contract during 2006, resulting in a net gain of $14 million recorded to
other income.
The remaining option contracts were written for a total of about 13 million common shares of NII Holdings
related to the forecasted sale of those shares in the fourth quarter 2006 and were designated as effective cash
flow hedges of a forecasted transaction pursuant to SFAS No. 133, as amended, and Derivative Implementation
Group Issue No. G-20, Assessing and Measuring the Effectiveness of a Purchased Option Used in a Cash
Flow Hedge. In the fourth quarter 2006, we sold our remaining investment of about 13 million common shares
of NII Holdings and settled the remaining option contracts using common shares of NII Holdings borrowed
under stock loan agreements. We recognized a gain of $396 million from the sale of the underlying shares,
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SPRINT NEXTEL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)