3M 2006 Annual Report Download - page 94

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agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by
reference to an agreed-upon notional principal amount.
At December 31, 2006, the Company had interest rate swaps designated as fair value hedges of underlying fixed rate
obligations (none at December 31, 2005). In June 2006, the Company entered into a $330 million fixed-to-floating interest
rate swap to hedge the 30-year bond due in 2028. In November 2006, the Company entered into a $400 million fixed-to-
floating interest rate swap concurrent with the issuance of the three-year medium-term note due in 2009. The mark-to-
market of these fair value hedges is recorded as gains or losses in interest expense and is offset by the gain or loss on
the underlying debt instrument, which also is recorded in interest expense. The fair value of these interest rate swaps was
$26 million as of December 31, 2006. These fair value hedges are 100% effective and, thus, there is no impact on
earnings due to hedge ineffectiveness.
Net Investment Hedging: As circumstances warrant, the Company uses cross currency swaps and forwards to hedge
SRUWLRQVRIWKH&RPSDQ\¶VQHWLQYHVWPHQWVLQIRUHLJQRSHUDWions. For hedges that meet the effectiveness requirements,
the net gains or losses attributable to changes in spot exchange rates are recorded in cumulative translation within other
comprehensive income. The remainder of the change in value of such instruments is recorded in earnings.
In September 2006, the Company entered into a three-year floating-to-floating cross currency swap with a notional
amount of $300 million. This transaction is a partial hedge of tKH&RPSDQ\¶VQHWLQYHVWPHQWLQLWV-DSDQHVHVXEVLGLDULHV
This swap converts U.S. dollar-based variable interest payments to yen-based variable interest payments associated with
the notional amount.
In November 2006, the Company entered into a three-year floating-to-floating cross currency swap with a notional
amount of $200 million. This transaction is a partial KHGJHRIWKH&RPSDQ\¶VQHWLQYHVWPHQWLQLWV(XURSHDQ
subsidiaries. This swap converts U.S. dollar-based variable interest payments to euro-based variable interest payments
associated with the notional amount.
In December 2006, the Company entered into foreign currency forward contracts with a notional amount of
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PLOOLRQUHODWLYHWRWKH&RPSDQ\¶VQHWLQYHVWPHQWLQ its Japanese subsidiaries. These forwards mature in
December 2007.
The unrealized loss recorded in cumulative translation related to net investment hedging at December 31, 2006 was
$18 million and the unrealized gain at December 31, 2005 was $47 million.
Currency Effects: 3M estimates that year-on-year currency effects, including hedging impacts, increased net income
by approximately $20 million in 2006, $115 million in 2005, and $181 million in 2004. This estimate includes the effect
of translating profits from local currencies into U.S. dollars; the impact of currency fluctuations on the transfer of goods
between 3M operations in the United States and abroad; and transaction gains and losses, including derivative
instruments designed to reduce foreign currency exchange rate risks. 3M estimates that year-on-year derivative and
other transaction gains and losses had an immaterial impact on net income in 2006 and increased net income by
approximately $50 million in 2005 and $48 million in 2004.
Credit risk: The Company is exposed to credit loss in the event of nonperformance by counterparties in interest rate
swaps, currency swaps, and option and foreign exchange contracts.+RZHYHUWKH&RPSDQ\¶VULVNLVOLPLWHGWRWKHIDLU
value of the instruments. The Company actively monitors its exposure to credit risk through the use of credit approvals
and credit limits, and by selecting major international banks and financial institutions as counterparties. The Company
does not anticipate non-performance by any of these counterparties. During the second quarter of 2006, the Company
entered into a credit support agreement with one of its primary derivatives counterparties. Under this agreement either
party is required to post eligible collateral when the market value of transactions covered by the agreement exceeds
specified thresholds, thus limiting credit exposure for both parties.
Fair value of financial instruments: At December 31, 2006 and 2005, the Company¶VILQDQFLDOLQVWUXPHQWVLQFOXGHGFDVK
and cash equivalents, marketable securities, accounts receivable, investments, accounts payable, borrowings, and
derivative contracts. The fair values of cash and cash equivalents, accounts receivable, accounts payable, and short-term
borrowings and current portion of long-term debt (except the $350 million dealer remarketable security) approximated
carrying values because of the short-term nature of these instruments. Available-for-sale marketable securities,
investments and derivative contracts are reported at fair values. Fair values for investments held at cost are not readily
available, but are estimated to approximate fair value. The carrying amounts and estimated fair values of other financial
instruments based on third-party quotes as of December 31 follow: