Verizon Wireless 2007 Annual Report Download - page 60

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Notes to Consolidated Financial Statements continued
NOTE 12
FINANCIAL INSTRUMENTS
Derivatives
The ongoing effect of SFAS No. 133 and related amendments and inter-
pretations on our consolidated financial statements will be determined
each period by several factors, including the specific hedging instru-
ments in place and their relationships to hedged items, as well as market
conditions at the end of each period.
Interest Rate Risk Management
We have entered into domestic interest rate swaps to achieve a targeted
mix of fixed and variable rate debt, where we principally receive fixed
rates and pay variable rates based on LIBOR. These swaps hedge against
changes in the fair value of our debt portfolio. We record the interest rate
swaps at fair value in our balance sheet as assets and liabilities and adjust
debt for the change in its fair value due to changes in interest rates.
We also enter into interest rate derivatives to limit our exposure to interest
rate changes. In accordance with the provisions of SFAS No. 133, changes
in fair value of these cash flow hedges due to interest rate fluctuations
are recognized in Accumulated Other Comprehensive Loss. Amounts
recorded to Other Comprehensive Income related to these interest rate
cash flow hedges for the years ended December 31, 2007, 2006 and 2005
were not material.
Net Investment Hedges
During 2007, we entered into foreign currency forward contracts to hedge
a portion of our net investment in Vodafone Omnitel. Changes in fair
value of these contracts due to Euro exchange rate fluctuations are rec-
ognized in Accumulated Other Comprehensive Loss and partially offset
the impact of foreign currency changes on the value of our net invest-
ment. As of December 31, 2007, Accumulated Other Comprehensive Loss
includes unrecognized losses of approximately $57 million ($37 million
after-tax) related to these hedge contracts, which along with the unre-
alized foreign currency translation balance on the investment hedged,
remain in Accumulated Other Comprehensive Loss until the investment
is sold.
During 2005, we entered into zero cost Euro collars to hedge a portion
of our net investment in Vodafone Omnitel. During 2005, our positions
in the zero cost euro collars were settled. As of December 31, 2007 and
2006, Accumulated Other Comprehensive Loss includes unrecognized
gains of $2 million in each year related to these hedge contracts, which
along with the unrealized foreign currency translation balance of the
investment hedged, remain in Accumulated Other Comprehensive Loss
until the investment is sold.
Other Derivatives
On May 17, 2005, we purchased 43.4 million shares of MCI common stock
under a stock purchase agreement that contained a provision for the
payment of an additional cash amount determined immediately prior to
April 9, 2006 based on the market price of Verizon’s common stock. Under
SFAS No. 133, this additional cash payment was an embedded derivative
which we carried at fair value and was subject to changes in the market
price of Verizon stock. Since this derivative did not qualify for hedge
accounting under SFAS No. 133, changes in its fair value were recorded in
the consolidated statements of income in Other Income and (Expense),
Net. As of December 31, 2006, this embedded derivative expired with
no requirement for an additional cash payment to be made under the
stock purchase agreement. During 2006 and 2005, we recorded pretax
income of $4 million and $57 million, respectively, in connection with this
embedded derivative.
Concentrations of Credit Risk
Financial instruments that subject us to concentrations of credit risk con-
sist primarily of temporary cash investments, short-term and long-term
investments, trade receivables, certain notes receivable, including lease
receivables, and derivative contracts. Our policy is to deposit our tem-
porary cash investments with major financial institutions. Counterparties
to our derivative contracts are also major financial institutions. The finan-
cial institutions have all been accorded high ratings by primary rating
agencies. We limit the dollar amount of contracts entered into with any
one financial institution and monitor our counterparties’ credit ratings.
We generally do not give or receive collateral on swap agreements due
to our credit rating and those of our counterparties. While we may be
exposed to credit losses due to the nonperformance of our counterpar-
ties, we consider the risk remote and do not expect the settlement of
these transactions to have a material effect on our results of operations
or financial condition.
Fair Values of Financial Instruments
The tables that follow provide additional information about our signifi-
cant financial instruments:
Financial Instrument Valuation Method
Cash and cash equivalents and
short-term investments
Carrying amounts
Short- and long-term debt
(excluding capital leases)
Market quotes for similar terms
and maturities or future cash ows
discounted at current rates
Cost investments in unconsolidated
businesses, derivative assets
and liabilities and notes receivable
Future cash ows discounted at
current rates, market quotes
for similar instruments or other
valuation models
(dollars in millions)
At December 31, 2007 2006
Carrying
Amount Fair Value
Carrying
Amount Fair Value
Short- and long-term debt $ 30,845 $ 32,380 $ 36,000 $ 37,165
Cost investments in
unconsolidated businesses 315 315 270 270
Short- and long-term
derivative assets 61 61 31 31
Short- and long-term
derivative liabilities 57 57 10 10