Verizon Wireless 2010 Annual Report Download - page 35

33
Management’sDiscussionandAnalysis
ofFinancialConditionandResultsofOperations – As Adjusted continued
MARKET RISK
We are exposed to various types of market risk in the normal course of
business, including the impact of interest rate changes, foreign currency
exchange rate fluctuations, changes in investment, equity and commodity
prices and changes in corporate tax rates. We employ risk management
strategies, which may include the use of a variety of derivatives including
cross currency swaps, foreign currency and prepaid forwards and collars,
interest rate and commodity swap agreements and interest rate locks. We
do not hold derivatives for trading purposes.
It is our general policy to enter into interest rate, foreign currency and
other derivative transactions only to the extent necessary to achieve our
desired objectives in limiting our exposure to various market risks. Our
objectives include maintaining a mix of fixed and variable rate debt to
lower borrowing costs within reasonable risk parameters and to protect
against earnings and cash flow volatility resulting from changes in market
conditions. We do not hedge our market risk exposure in a manner that
would completely eliminate the effect of changes in interest rates and
foreign exchange rates on our earnings. We do not expect that our net
income, liquidity and cash flows will be materially affected by these risk
management strategies.
Interest Rate Risk
We are exposed to changes in interest rates, primarily on our short-term
debt and the portion of long-term debt that carries floating interest
rates. As of December 31, 2010, more than three-fourths in aggregate
principal amount of our total debt portfolio consisted of fixed rate
indebtedness, including the effect of interest rate swap agreements des-
ignated as hedges. The impact of a 100 basis point change in interest
rates affecting our floating rate debt would result in a change in annual
interest expense, including our interest rate swap agreements that are
designated as hedges, of approximately $0.1 billion. The interest rates on
our existing long-term debt obligations are unaffected by changes to our
credit ratings.
The table that follows summarizes the fair values of our long-term debt,
including current maturities, and interest rate swap derivatives as of
December 31, 2010 and 2009. The table also provides a sensitivity anal-
ysis of the estimated fair values of these financial instruments assuming
100-basis-point upward and downward shifts in the yield curve. Our sen-
sitivity analysis does not include the fair values of our commercial paper
and bank loans, if any, because they are not significantly affected by
changes in market interest rates.
(dollars in millions)
At December 31, 2010 Fair Values
Fair Value
assuming
+ 100 basis
point shift
Fair Value
assuming
- 100 basis
point shift
Long-term debt and related
derivatives $ 58,591 $ 55,427 $ 62,247
At December 31, 2009
Long-term debt and related
derivatives $ 66,042 $ 62,788 $ 69,801
Interest Rate Swaps
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LondonInterbankOfferedRate.
These swaps are designated as fair value hedges and hedge against
changes in the fair value of our debt portfolio. We record the interest
rate swaps at fair value on our consolidated balance sheets as assets and
liabilities. Changes in the fair value of the interest rate swaps are recorded
to Interest expense, which are offset by changes in the fair value of the
debt due to changes in interest rates. The fair value of these contracts
was $0.3 billion and $0.2 billion at December 31, 2010 and December 31,
2009, respectively, and are primarily included in Other assets and Long-
term debt. As of December 31, 2010, the total notional amount of these
interest rate swaps was $6.0 billion. During February 2011, we entered
into interest rate swaps, designated as fair value hedges, with a notional
amount of approximately $3.0 billion.
Forward Interest Rate Swaps
In order to manage our exposure to future interest rate changes, during
2010, we entered into forward interest rate swaps with a total notional
value of $1.4 billion. We have designated these contracts as cash flow
hedges. The fair value of these contracts was $0.1 billion at December
31, 2010 and the contracts are included in Other assets. On or before
February 7, 2011, Verizon terminated these forward interest rate swaps.
Foreign Currency Translation
The functional currency for our foreign operations is primarily the
local currency. The translation of income statement and balance sheet
amounts of our foreign operations into U.S. dollars are recorded as cumu-
lative translation adjustments, which are included in Accumulated other
comprehensive loss in our consolidated balance sheets. Gains and losses
on foreign currency transactions are recorded in the consolidated state-
ments of income in Other income and (expense), net. At December 31,
2010, our primary translation exposure was to the British Pound Sterling,
the Euro and the Australian Dollar.
Cross Currency Swaps
Verizon Wireless has entered into cross currency swaps designated as
cash flow hedges to exchange approximately $2.4 billion British Pound
Sterling and Euro denominated debt into U.S. dollars and to fix our future
interest and principal payments in U.S. dollars, as well as mitigate the
impact of foreign currency transaction gains or losses. The fair value of
these swaps included primarily in Other assets was approximately $0.1
billion and $0.3 billion at December 31, 2010 and December 31, 2009,
respectively. During 2010 and 2009, a pre-tax loss of $0.2 billion, and a
pre-tax gain of $0.3 billion, respectively, was recognized in Other compre-
hensive income, a portion of which was reclassified to Other income and
(expense), net to offset the related pre-tax foreign currency transaction
gain on the underlying debt obligations.