TOPIC: Managing Economic Exposure And Translation Exposure

What Does Economic Exposure Mean? An exposure to fluctuating exchange rates, which affects a company's earnings, cash flow and foreign investments. The extent to which a

company is affected by economic exposure depends on the specific characteristics of the company and its industry. Economic Exposure Most large companies attempt to minimize the risk of fluctuating exchange rates by hedging with positions in the forex market. Companies that do a lot of business in many countries, such as import/export companies, are at particular risk for economic liabilities or income in a foreign currency. exposure.
What Does Translation Exposure Mean?

The risk that a company's equities, assets, liabilities or income will change in value as a result of exchange rate changes. This occurs when a firm denominates a portion of its equities, assets,

 To explain how an MNC’s economic exposure can be hedged; and  To explain how an MNC’s translation exposure can be hedged. The economic impact of currency exchange rates on us is complex because such changes are often linked to variability in real growth, inflation, interest rates, governmental actions, and other factors. These changes, if material, can cause us to adjust our financing and operating strategies. • Use of the Income Statement to an MNC can determine its exposure by assessing the sensitivity of its cash inflows and outflows to various possible exchange rate scenarios. The MNC can then reduce its exposure by restructuring its operations to balance its exchange-rate-sensitive cash flows.

Note that computer spreadsheets are often used to expedite the analysis Assess Economic ExposureManaging Madison Inc.’s Economic Exposure

Madison’s earnings before taxes is inversely related to the Canadian dollar’s strength, since the higher expenses more than offset the higher revenue when the Canadian dollar strengthens.

Madison may reduce its exposure by increasing Canadian sales, reducing orders of Canadian materials, and borrowing less in Canadian dollars • How Restructuring Can Restructuring to reduce economic exposure involves shifting the sources of costs or revenue to other locations in order to match cash inflows and outflows in foreign currencies. The proposed structure is then evaluated by assessing the sensitivity of its cash inflows and outflows to various possible exchange rate scenarios. Reduce HedgWhen an MNC has fixed assets (such as buildings or machinery) in a foreign country, the cash flows to be received from the sale of these assets is subject to exchange rate risk. A sale of fixed assets can be hedged by creating a liability that matches the expected value of the assets at the point in the future when they will be sold.

Exposure to Fixed Assets Economic Exposure • Translation exposure results when an MNC translates each subsidiary’s financial data to its home currency for consolidated financial reporting.

Translation exposure does not directly affect cash flows, but some firms are concerned about it because of its potential impact on reported consolidated earningsslation Exposure Use of Forward Contracts to Hedge Translation Exposure To hedge translation exposure, forward or futures contracts can be used. Specifically, an MNC may sell the currency that its foreign subsidiary receive as earnings forward, thus creating an offsetting cash outflow in that currency Use of Forward Contracts to Hedge Translation Exposure


¤ A U.S.-based MNC has a British subsidiary. ¤ The forecasted British earnings of £20 million (to be entirely reinvested) will be translated at the weighted average £ value over the year. ¤ To hedge this expected earnings, the MNC sells £20 million one year forward. ¤ If the £ depreciates, the gain generated from the forward contract position will help to offset the translation loss.
Limitations of Hedging Translation Exposure  Inaccurate earnings forecasts  Inadequate forward contracts for some currencies  Accounting distortions

¤ Translation gains/losses are based on the average exchange rate (which is unlikely to be the same as the forward rate). ¤ Translation losses are also not tax deductible.
 Increased transaction exposure ¤

If the foreign currency appreciates during the fiscal year, the transaction loss generated by a forward contract position will somewhat offset the translation gain. The translation gain is simply a paper gain, while the loss resulting from the hedge is a real loss.


The Coca-Cola Company is the largest manufacturer, distributor and marketer of nonalcoholic beverage concentrates and syrups in the world. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200

countries. Along with Coca-Cola, which is recognized as theworld’s most valuable brand, we market four of the world’s top five nonalcoholic sparkling brands, including Diet Coke, Fanta and Sprite. In this report, the terms ‘‘Company,’’ ‘‘we,’’ ‘‘us’’ or ‘‘our’’ mean The Coca-Cola
Company and all entities included in our consolidated financial statements.Our business is nonalcoholic beverages—principally sparkling beverages, but also a variety of stillbeverages. We manufacture beverage concentrates and syrups, which we sell to bottling and canning operations,fountain wholesalers and some fountain retailers, as well as finished beverages, which we sell primarily todistributors. Our Company owns or licenses nearly 500 brands, including diet and light beverages, waters,enhanced waters, juices and juice drinks, teas, coffees, and energy and sports drinks. In addition, we haveownership interests in numerous beverage joint ventures, bottling and canning operations, although most of these operations are independently owned and managed. We were incorporated in September 1919 under the laws of the State of Delaware and succeeded to the business of a Georgia corporation with the same name that had been organized in 1892.

Our Company is one of numerous competitors in the commercial beverages market. Of the approximately 54 billion beverage servings of all types consumed worldwide every day, beverages bearing trademarks owned byor licensed to us account for approximately 1.6 billion. We believe that our success depends on our ability to connect with consumers by providing them with awide variety of choices to meet their desires, needs and lifestyle choices. Our success further depends on the ability of our people to execute effectively, every day. Our goal is to use our Company’s assets—our brands, financial strength, unrivaled distribution system,global reach and the talent and strong commitment of our management and associates—to become more competitive and to accelerate growth in a manner that creates value for our shareowners.

HEDGING TRANSACTIONS AND DERIVATIVE FINANCIAL INSTRUMENTS When deemed appropriate, our Company uses derivative financial instruments primarily to reduce our exposure to adverse fluctuations in interest rates and foreign currency exchange rates, commodity prices andother market risks. The Company formally designates and documents the financial instrument as a hedge of a specific underlying exposure, as well as the risk management objectives and strategies for undertaking the hedge transactions. The Company formally assesses, both at the inception and at least quarterly thereafter, whether thefinancial instruments that are used in hedging transactions are effective at offsetting changes in either the fair value or cash flows of the related underlying exposure. Because of the high degree of effectiveness between the hedging instrument and the underlying exposure being hedged, fluctuations in the value of the derivative instruments are generally offset by changes in the fair values or cash flows of the underlying exposures being hedged. Any ineffective portion of a financial instrument’s change in fair value is immediately recognized in earnings. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets. Our Company does not enter into derivative financial instruments for trading purposes.The fair values of derivatives used to hedge or modify our risks fluctuate over time, and are determined in accordance with SFAS No. 157. Refer to Note 12. We do not view these fair value amounts in isolation, but rather in relation to the fair values or cash flows of the underlying hedged transactions or other exposures. The notional amounts of the derivative financial instruments do not necessarily represent amounts exchanged by theparties and, therefore, are not a direct measure of our exposure to the financial risks described above. The amounts exchanged are calculated by reference to the notional amounts and by other terms of the derivatives, such as interest rates, foreign currency exchange rates or other financial indices.

Our Company recognizes all derivative instruments as either assets or liabilities in our consolidated balance sheets at fair value. The accounting for changes in fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and, further, on the type of hedging relationship. At the inception of the hedging relationship, the Company must designate the instrument as a fair value hedge, a cash flow hedge, or a hedge of a net investment in a foreign operation. This designation is based upon the exposure being hedged. We have established strict counterparty credit guidelines and enter into transactions only with financial institutions of investment grade or better. We monitor counterparty exposures daily and review any downgrade in credit rating immediately. If a downgrade in the credit rating of a counterparty were to occur, we have provisions requiring collateral in the form of U.S. government securities for substantially all of our transactions.To mitigate presettlement risk, minimum credit standards become more stringent as the duration of the derivative financial instrument increases. To minimize the concentration of credit risk, we enter into derivative transactions with a portfolio of financial institutions. The Company has master netting agreements with most of the financial institutions that are counterparties to the derivative instruments. These agreements allow for the net settlement of assets and liabilities arising from different transactions with the same counterparty. Based on these factors, we consider the risk of counterparty default to be minimal.

Interest Rate Management
Our Company monitors our mix of fixed-rate and variable-rate debt as well as our mix of short-term debt versus long-term debt. This monitoring includes a review of business and other financial risks. From time to time, in anticipation of future debt issuances, we may manage our risk to interest rate fluctuations through the use of derivative financial instruments. During 2008, the Company discontinued a cash flow hedging relationship on interest rate locks, as it was no longer probable that we would issue the long-term debt for which these hedges were designated. As a result, the Company reclassified a previously unrecognized gain of approximately $17 million from AOCI to earnings as a reduction to interest expense. Additionally, during 2008 the Company recognized losses of approximately $9 million related to the portion of cash flow hedges deemed to be ineffective as an increase to interest expense.Any ineffective portion, which was not significant, of these instruments during 2007 and 2006 was immediately recognized in net income. Foreign Currency Management The purpose of our foreign currency hedging activities is to reduce the risk that our eventual U.S. dollar netcash inflows resulting from sales outside the United States will be adversely affected by changes in foreign currency exchange rates. We enter into forward exchange contracts and purchase foreign currency options (principally euro and Japanese yen) and collars to hedge certain portions of forecasted cash flows denominated in foreign currencies. The effective portion of the changes in fair value for these contracts, which have been designated as foreign currency cash flow hedges, was reported in AOCI and reclassified into earnings in the same financial statement line item and in the same period or periods during which the hedged transaction affects earnings.

The Company did not discontinue any foreign currency cash flow hedging relationships during the years ended December 31,2008, 2007 and 2006. Any ineffective portion, which was not significant in 2008, 2007 or 2006, of the change in the fair value of these instruments was immediately recognized in net income.

Additionally, the Company enters into forward exchange contracts that are effective economic hedges and are not designated as hedging instruments under SFAS No. 133. These instruments are used to offset theearnings impact relating to the variability in foreign currency exchange rates on certain monetary assets and liabilities denominated in nonfunctional currencies. Changes in the fair value of these instruments are immediately recognized in earnings in the line item other income (loss)—net in our consolidated statements ofincome to offset the effect of remeasurement of the monetary assets and liabilities. The Company also enters into forward exchange contracts to hedge its net investment position in certain major currencies. Under SFAS No. 133, changes in the fair value of these instruments are recognized in foreign currency translation adjustment, a component of AOCI, to offset the change in the value of the net investment being hedged. For the years ended December 31, 2008, 2007 and 2006, we recorded net gain (loss) in foreigncurrency translation adjustment related to those instruments of approximately $3 million, $(7) million and$3 million, respectively.Commodities.

The Company enters into commodity futures and other derivative instruments to mitigate exposure to fluctuations in commodity prices and other market risks. We purchase commodity futures to hedge forecasted cash flows related to future purchases of certain commodities. The effective portion of the changes in fair value for these contracts, which have been designated as commodity cash flow hedges, are reported in AOCI and reclassified into earnings in the same financial statement line item and in the same period or periods during which the hedged transaction affects earnings. TheCompany did not discontinue any commodity cash flow hedging relationships during the years ended December 31, 2008, 2007 and 2006. Any ineffective portion, which was not significant in 2008, 2007 or 2006, of the change in the fair value of these instruments was immediately recognized in net income. The following tables present the carrying values, fair values and maturities of the Company’s derivative instruments outstanding as of December 31, 2008 and 2007 (in millions): Carrying Values Fair Values Assets/(Liabilities) Assets/(Liabilities) Maturity 2008 Foreign currency forward contracts $ (124) $ (124) 2009-2010 Foreign currency options and collars 12 12 2009-2010 Interest rate locks (43) (43) 2009

Commodity futures (42) (42) 2009-2010 Other derivative instruments (17) (17) 2009 $ (214) $ (214) Does not include the impact of approximately $8 million of cash collateral held or placed with the 1 same counterparties. 104

THE COCA-COLA COMPANY AND SUBSIDIARIES HEDGING TRANSACTIONS AND DERIVATIVE FINANCIAL INSTRUMENTS Carrying Values Fair Values Assets/(Liabilities) Assets/(Liabilities) Maturity 2007 Foreign currency forward contracts $ (58) $ (58) 2008-2009 Foreign currency options and collars 46 46 2008 Interest rate locks — — N/A Commodity futures 1 1 2008

Other derivative instruments 28 28 2008 $17 $17 The Company estimates the fair values of its derivatives based on quoted market prices or pricing models using current market rates, and records them as prepaid expenses and other assets or accounts payable andaccrued expenses in our consolidated balance sheets. The amounts recorded reflect the effect of legally enforceable master netting agreements that allow the Company to settle positive and negative positions and cash collateral held or placed with the same counterparties. As of December 31, 2008, we had approximately$5 million reflected in prepaid expenses and other assets and $211 million reflected in accounts payable and accrued expenses.

Bank of America serves one in two U.S. households, virtually the entire U.S. Fortune 1000 and clients around the world. We built this company to serve customers and clients wherever and however they choose, and to return value to shareholders.We understand that we play an important role as an engine of growth and a partner for success for millions of individuals, families and businesses of every size. As we emerge from the economic crisis of the past two years, we also have the opportunity — and the obligation — to address a simple question I often hear: “What is Bank of America doing to make financial services better?” It’s a good question. My answer is, we’re working to improve our ability to support the financial health of all those we serve. To provide financial solutions that are clearly explained and easily understood. To take our seat at the table with policy-makers at every level and help create a financial system that supports economic growth and

financial stability. And to do all this through a business model that generates attractive returns for you — our shareholders.

Interest rate and foreign exchange derivative contracts are utilized in our Accumulated OCI includes $1.5 billion in after-tax gains at ALM activities and serve as an efficient tool to manage our interest rate December 31, 2009, including $628 million of net unrealized losses and foreign exchange risk. We use derivatives to hedge the variability in related to AFS debt securities and $2.1 billion of net unrealized gains cash flows or changes in fair value on our balance sheet due to interest related to AFS marketable equity securities. Total market value of the AFS rate and foreign exchange components. For additional information on our debt securities was $301.6 billion at December 31, 2009 with a hedging activities, see Derivatives to the Consolidated Financial weighted-average duration of 4.5 years and primarily relates to our MBS Statements. portfolio. Our interest rate contracts are generally non-leveraged generic interest.The amount of pre-tax accumulated OCI loss related to AFS debt secu-rate and foreign exchange basis swaps, options, futures and forwards. In rites decreased by $8.3 billion during 2009 to $1.0 billion. For those addition, we use foreign exchange contracts, including cross-currency securities that are in an unrealized loss position, we have the intent and interest rate swaps and foreign currency forward contracts, to mitigate the ability to hold these securities to recovery and it is more likely than not foreign exchange risk associated with foreign currency-denominated that we will not be required to sell the securities prior to recovery. assets and liabilities. Table 46 reflects the notional amounts, fair value, We recognized $2.8 billion of other-than-temporary impairment losses weightedaverage receive fixed and pay fixed rates, expected maturity and

through earnings on AFS debt securities during 2009 compared to $3.5 estimated duration of our open ALM derivatives at December 31, 2009 billion during 2008. We also recognized $326 million of otherthan- and 2008. These amounts do not include derivative hedges on our net temporary impairment losses on AFS marketable equity securities during investments in consolidated foreign operations and MSRs. 2009 compared to $661 million during 2008. Changes to the composition of our derivatives portfolio during 2009 ,The impairment of AFS debt and marketable equity securities is based reflect actions taken for interest rate and foreign exchange rate risk on a variety of factors, including the length of time and extent to which management. The decisions to reposition our derivatives portfolio are the market value has been less than cost; the financial condition of the based upon the current assessment of economic and financial conditions issuer of the security and its ability to recover market value; and our including the interest rate environment, balance sheet composition and intent and ability to hold the security to recovery. Based on our evaluation trends, and the relative mix of our cash and derivative positions. The of the above and other relevant factors, and after consideration of the notional amount of our option positions increased to $6.5 billion at losses described in the paragraph above, we do not believe that the AFS December 31, 2009 from $5.0 billion at December 31, 2008. Changes debt and marketable equity securities that are in an unrealized loss posi- in the levels of the option positions were driven by swaptions acquired as tion at December 31, 2009 are other-than-temporarily impaired. a result of the Merrill Lynch acquisition. Our interest rate swap positions We adopted new accounting guidance related to the recognition and (including foreign exchange contracts) were a net receive fixed position of presentation of other-than-temporary impairment of debt securities as of $52.2 billion at December 31, 2009 compared to a net receive fixed ,January 1, 2009. As prescribed by the new guidance, at December 31, position of $50.3 billion at December 31, 2008.

Changes in the notional 2009, we recognized the credit component of other-than-temporary levels of our interest rate swap position were driven by the net addition of 96 Bank of America 2009 ,$104.4 billion in pay fixed swaps, $83.4 billion in U.S. dollar The following table includes derivatives utilized in our ALM activities receive fixed swaps and the net addition of $22.9 billion in including those designated as accounting and economic hedging instru-foreign currency-denominated receive fixed swaps.The fair value of net ALM contracts increased $5.8 billion to our foreign exchange basis swaps was $122.8 billion and $54.6 billion at gain of $12.3 billion at December 31, 2009 from a gain of $6.4 billion at December 31, 2009 and 2008. The $42.9 billion increase in same-December 31, 2008. The increase was primarily attributable to changes currency basis swap positions was primarily due to the acquisition of in the value of U.S. dollar-denominated receive fixed interest rate swaps Merrill Lynch. Our futures and forwards net notional position, which of $1.9 billion, foreign exchange basis swaps of $1.4 billion, pay fixed reflects the net of long and short positions, was a long position of $10.6 interest rate swaps of $1.2 billion, foreign exchange contracts of $1.1billion compared to a short position of $8.8 billion at December 31,billion, option products of $174 million and same-currency basis swaps of2008.$107 million. The increase was partially offset by a loss from changes in the value of futures and forward rate contracts of $66 million.

IBM INTERNATIONAL BUSINESS MACHINE The company has exited commoditizing businesses and remixed its portfolio to higher value areas through organic investments and acquisitions. This shift to higher value areas drives a more profitable mix and enables the company to better meet clients’ needs. In addition, the focus on global integration has improved productivity and efficiency. The company’s ongoing initiatives have reduced the fixed cost base and improved the operational balance point— generating more profit for each dollar of revenue. The strong profit and cash base has enabled the company to make significant investments for growth and return capital to shareholders. Key areas of investment include Smarter Planet solutions, business analytics, growth market opportunities and new computing models such as cloud computing. The strategic transformation of the company has enabled the company to deliver strong financial performance since the last recession in 2002, including the difficult environment in 2008 and 2009, and has positioned the business for the future.

For the year, the company delivered $10.01 in diluted earnings per share, an increase of 12.6 percent year to year. This was the seventh consecutive year of double-digit earnings per share growth. In 2007, the company developed a road map for growth with an earnings per share objective for 2010 of $10 to $11 per share. With its performance in 2009, the company achieved this objective one year early.In 2009, in a difficult global economic environment, the company continued to deliver value to its clients and strong financial results to its investors—with profit growth driven by continued margin expansion, expense productivity, market share gains in software and systems and a continuing strong cash position. The company again achieved record levels of pre-tax profit, earnings per share and cash flow from operations—despite a decline in revenue. The financial

performance reflected the strength of the company’s global model and the results of the strategic transformation of the business. (IBM or the company) 2009 Annual Report includes the Management Discussion, the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements. In 2009, the company’s revenue decreased 7.6 percent as reported and 5.3 percent adjusted for currency. In the first nine months of 2009, revenue decreased 10.6 percent as reported and 5.3 percent adjusted for currency. This currency impact reversed in the fourth quarter, as revenue increased 0.8 percent as reported and declined 5.5 percent adjusted for currency, driven from the company’s operations in currencies other than the U.S. dollar. The company maintains currency hedging programs for cash planning purposes which mitigate, but do not eliminate, the volatility of currency impacts on the company’s financial results. In addition to the translation of earnings, the impact of currency changes also may affect the company’s pricing and sourcing actions. For example, the company may procure components and supplies in multiple functional currencies and sell products and services in other currencies. The company believes that some of these currency-based changes in cost impact the price charged to clients. However, the company estimates that the effect of currency, before taking pricing or sourcing actions into account, and net of hedging activity, had no more than a $0.09 impact on earnings per share growth in 2009.

Derivatives All derivatives are recognized in the Consolidated Statement of Financial Position at fair value and are reported in prepaid expenses and other current assets, investments and sundry assets, other accrued expenses and liabilities or other liabilities. Classification of each derivative as current or noncurrent is based upon whether the maturity of the instrument is less than or greater than 12 months. To qualify for hedge accounting, the company requires that the instruments be effective in reducing the risk exposure that they are hedge cash flows, hedge effectiveness criteria also require that it be probable that the underlying transaction will occur. Instruments that meet established accounting criteria are formally designated as hedges. These criteria demonstrate that the derivative is expected to be highly effective at offsetting changes in fair value or cash flows of the underlying exposure both at inception of the hedging relationship and on an ongoing basis. The method of assessing hedge effectiveness and measuring hedge ineffectiveness is formally documented at hedge inception. The company assesses hedge effectiveness and measures hedge ineffectiveness at least quarterly throughout the designated hedge period.

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