Verizon Wireless 2012 Annual Report Download - page 69

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS continued
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NOTE 9
FAIR VALUE MEASUREMENTS AND FINANCIAL INSTRUMENTS
The following table presents the balances of assets measured at fair value
on a recurring basis as of December 31, 2012:
(dollars in millions)
Level 1(1) Level 2(2) Level 3(3) Total
Assets:
Short-term investments:
Equity securities $ 310 $ – $ – $ 310
Fixed income securities – 160 – 160
Other current assets:
Interest rate swaps – 7 – 7
Other assets:
Fixed income securities – 943 – 943
Cross currency swaps – 153 – 153
Total $ 310 $ 1,263 $ – $ 1,573
(1) quoted prices in active markets for identical assets or liabilities
(2) observable inputs other than quoted prices in active markets for identical assets and
liabilities
(3) no observable pricing inputs in the market
Equity securities consist of investments in common stock of domestic
and international corporations measured using quoted prices in active
markets.
Fixed income securities consist primarily of investments in municipal
bonds that do not have quoted prices in active markets. For these securi-
ties, we use alternative matrix pricing resulting in these debt securities
being classified as Level 2.
Derivative contracts are valued using models based on readily observable
market parameters for all substantial terms of our derivative contracts
and thus are classified within Level 2. We use mid-market pricing for fair
value measurements of our derivative instruments.
We recognize transfers between levels of the fair value hierarchy as of the
end of the reporting period. There were no transfers within the fair value
hierarchy during 2012.
Fair Value of Short-term and Long-term Debt
The fair value of our debt is determined using various methods, including
quoted prices for identical terms and maturities, which is a Level 1 mea-
surement, as well as quoted prices for similar terms and maturities in
inactive markets and future cash flows discounted at current rates, which
are Level 2 measurements. The fair value of our short-term and long-term
debt, excluding capital leases, was as follows:
(dollars in millions)
At December 31, 2012 2011
Carrying
Amount Fair Value
Carrying
Amount Fair Value
Short- and long-term debt,
excluding capital leases $ 51,689 $ 61,552 $ 54,800 $ 64,485
Derivative Instruments
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.
Forward Interest Rate Swaps
In order to manage our exposure to future interest rate changes, during
the second quarter of 2012, we entered into forward interest rate swaps
with a notional value of $1.0 billion. We designated these contracts as
cash flow hedges. In November 2012, we settled these forward interest
rate swaps and the pretax loss was not material.
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.
Prepaid Forward Agreement
During the first quarter of 2009, we entered into a privately negotiated
prepaid forward agreement for 14 million shares of Verizon common
stock at a cost of approximately $0.4 billion. We terminated the prepaid
forward agreement with respect to 5 million of the shares during the
fourth quarter of 2009 and 9 million of the shares during the first quarter
of 2010, which resulted in the delivery of those shares to Verizon.
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.