Verizon Wireless 2012 Annual Report Download - page 43

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We are exposed to various types of market risk in the normal course
of business, including the impact of interest rate changes, foreign cur-
rency 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 deriva-
tives including cross currency swaps, foreign currency and prepaid
forwards and collars, interest rate swap agreements, commodity swap
and forward agreements and interest rate locks. We do not hold deriva-
tives 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, 2012, substantially all of the aggregate principal
amount of our total debt portfolio consisted of fixed rate indebtedness,
including the effect of interest rate swap agreements designated 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, that is not material. 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, 2012 and 2011. 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, 2012 FairValue
FairValue
assuming
+ 100 basis
point shift
FairValue
assuming
- 100 basis
point shift
Long-term debt and related derivatives $ 61,045 $ 56,929 $ 65,747
At December 31, 2011
Long-term debt and related derivatives $ 61,870 $ 58,117 $ 66,326
Interest Rate Swaps
We have entered into domestic interest rate swaps to achieve a targeted
mix of fixed and variable rate debt. We principally receive fixed rates and
payvariableratesbasedontheLondonInterbankOfferedRate,resulting
in a net increase or decrease to Interest expense. These swaps are desig-
nated 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. At December
31, 2012 the fair value of these interest rate swaps was not material, and
at December 31, 2011, the fair value was $0.6 billion, primarily included
in Other assets and Long-term debt. As of December 31, 2012, the total
notional amount of these interest rate swaps was $1.3 billion. During
2012, interest rate swaps with a notional value of $5.8 billion were settled.
As a result of the settlements, we received net proceeds of $0.7 billion,
including accrued interest which is included in Other, net operating
activities in the consolidated statement of cash flows. The fair value basis
adjustment to the underlying debt instruments will be recognized into
earnings as a reduction of Interest expense over the remaining lives of
the underlying debt obligations.
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isrecordedascumu-
lative translation adjustments, which are included in Accumulated other
comprehensive income in our consolidated balance sheets. Gains and
losses on foreign currency transactions are recorded in the consoli-
dated statements of income in Other income and (expense), net. At
December 31, 2012, our primary translation exposure was to the British
PoundSterling,theEuro,theIndianRupee,theAustralianDollarandthe
JapaneseYen.
Cross Currency Swaps
Verizon Wireless previously entered into cross currency swaps designated
as cash flow hedges to exchange approximately $1.6 billion of 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to
mitigate the impact of foreign currency transaction gains or losses. A por-
tion of the gains and losses recognized in Other comprehensive income
was reclassified to Other income and (expense), net to offset the related
pretax foreign currency transaction gain or loss on the underlying debt
obligations. The fair value of the outstanding swaps was not material at
December 31, 2012 or December 31, 2011. During 2012 and 2011 the
gains and losses with respect to these swaps were not material.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS continued
market risk