NOTE 5 — DERIVATIVES
We use derivative instruments to manage risks related to foreign currencies, equity prices, interest rates, and credit; to enhance investment returns; and to facilitate portfolio diversification. Our objectives for holding derivatives include reducing, eliminating, and efficiently managing the economic impact of these exposures as effectively as possible.
Our derivative programs include strategies that both qualify and do not qualify for hedge accounting treatment. All notional amounts presented below are measured in U.S. dollar equivalents.
Foreign Currency
Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency hedge positions. Option and forward contracts are used to hedge a portion of forecasted international revenue for up to three years in the future and are designated as cash flow hedging instruments. Principal currencies hedged include the euro, Japanese yen, British pound, and Canadian dollar. As of June 30, 2013 and June 30, 2012, the total notional amounts of these foreign exchange contracts sold were $5.1 billion and $6.7 billion, respectively.
Foreign currency risks related to certain non-U.S. dollar denominated securities are hedged using foreign exchange forward contracts that are designated as fair value hedging instruments. As of June 30, 2013 and June 30, 2012, the total notional amounts of these foreign exchange contracts sold were $407 million and $1.3 billion, respectively.
Certain options and forwards not designated as hedging instruments are also used to manage the variability in exchange rates on accounts receivable, cash, and intercompany positions, and to manage other foreign currency exposures. As of June 30, 2013, the total notional amounts of these foreign exchange contracts purchased and sold were $5.0 billion and $7.9 billion, respectively. As of June 30, 2012, the total notional amounts of these foreign exchange contracts purchased and sold were $3.6 billion and $7.3 billion, respectively.
Equity
Securities held in our equity and other investments portfolio are subject to market price risk. Market price risk is managed relative to broad-based global and domestic equity indices using certain convertible preferred investments, options, futures, and swap contracts not designated as hedging instruments. From time to time, to hedge our price risk, we may use and designate equity derivatives as hedging instruments, including puts, calls, swaps, and forwards. As of June 30, 2013, the total notional amounts of designated and non-designated equity contracts purchased and sold were $898 million and $1.0 billion, respectively. As of June 30, 2012, the total notional amounts of designated and non-designated equity contracts purchased and sold were $1.4 billion and $982 million, respectively.
Interest Rate
Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of our fixed-income portfolio to achieve economic returns that correlate to certain broad-based fixed-income indices using exchange-traded option and futures contracts and over-the-counter swap and option contracts, none of which are designated as hedging instruments. As of June 30, 2013, the total notional amounts of fixed-interest rate contracts purchased and sold were $1.1 billion and $809 million, respectively. As of June 30, 2012, the total notional amounts of fixed-interest rate contracts purchased and sold were $3.2 billion and $1.9 billion, respectively.
In addition, we use “To Be Announced” forward purchase commitments of mortgage-backed assets to gain exposure to agency mortgage-backed securities. These meet the definition of a derivative instrument in cases where physical delivery of the assets is not taken at the earliest available delivery date. As of June 30, 2013 and 2012, the total notional derivative amounts of mortgage contracts purchased were $1.2 billion and $1.1 billion, respectively.
Credit
Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default swap contracts, not designated as hedging instruments, to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. We use credit default swaps as they are a low cost method of managing exposure to individual credit risks or groups of credit risks. As of June 30, 2013, the total notional amounts of credit contracts purchased and sold were $377 million and $501 million, respectively. As of June 30, 2012, the total notional amounts of credit contracts purchased and sold were $318 million and $456 million, respectively.
Commodity
We use broad-based commodity exposures to enhance portfolio returns and to facilitate portfolio diversification. We use swaps, futures, and option contracts, not designated as hedging instruments, to generate and manage exposures to broad-based commodity indices. We use derivatives on commodities as they can be low-cost alternatives to the purchase and storage of a variety of commodities, including, but not limited to, precious metals, energy, and grain. As of June 30, 2013, the total notional amounts of commodity contracts purchased and sold were $1.2 billion and $249 million, respectively. As of June 30, 2012, the total notional amounts of commodity contracts purchased and sold were $1.5 billion and $445 million, respectively.
Credit-Risk-Related Contingent Features
Certain of our counterparty agreements for derivative instruments contain provisions that require our issued and outstanding long-term unsecured debt to maintain an investment grade credit rating and require us to maintain minimum liquidity of $1.0 billion. To the extent we fail to meet these requirements, we will be required to post collateral, similar to the standard convention related to over-the-counter derivatives. As of June 30, 2013, our long-term unsecured debt rating was AAA, and cash investments were in excess of $1.0 billion. As a result, no collateral was required to be posted.
Fair Values of Derivative Instruments
The following tables present the gross fair values of derivative instruments designated as hedging instruments (“designated hedge derivatives”) and not designated as hedging instruments (“non-designated hedge derivatives”). The fair values exclude the impact of netting derivative assets and liabilities when a legally enforceable master netting agreement exists and fair value adjustments related to our own credit risk and counterparty credit risk:
| (In millions) |
Foreign Exchange Contracts |
Equity Contracts |
Interest Rate Contracts |
Credit Contracts |
Commodity Contracts |
Total Derivatives |
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| June 30, 2013 | ||||||||||||||||||||||||
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Non-designated hedge derivatives: |
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Short-term investments |
$ | 41 | $ | 157 | $ | 18 | $ | 19 | $ | 3 | $ | 238 | ||||||||||||
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Other current assets |
87 | 0 | 0 | 0 | 0 | 87 | ||||||||||||||||||
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Total |
$ | 128 | $ | 157 | $ | 18 | $ | 19 | $ | 3 | $ | 325 | ||||||||||||
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Designated hedge derivatives: |
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Short-term investments |
$ | 9 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 9 | ||||||||||||
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Other current assets |
167 | 0 | 0 | 0 | 0 | 167 | ||||||||||||||||||
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Total |
$ | 176 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 176 | ||||||||||||
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Total assets |
$ | 304 | $ | 157 | $ | 18 | $ | 19 | $ | 3 | $ | 501 | ||||||||||||
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| Liabilities | ||||||||||||||||||||||||
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Non-designated hedge derivatives: |
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Other current liabilities |
$ | (63 | ) | $ | (9 | ) | $ | (45 | ) | $ | (17 | ) | $ | (1 | ) | $ | (135 | ) | ||||||
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Designated hedge derivatives: |
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Other current liabilities |
$ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||||||
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Total liabilities |
$ | (63 | ) | $ | (9 | ) | $ | (45 | ) | $ | (17 | ) | $ | (1 | ) | $ | (135 | ) | ||||||
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| (In millions) |
Foreign Exchange Contracts |
Equity Contracts |
Interest Rate Contracts |
Credit Contracts |
Commodity Contracts |
Total Derivatives |
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| June 30, 2012 | ||||||||||||||||||||||||
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Non-designated hedge derivatives: |
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Short-term investments |
$ | 14 | $ | 162 | $ | 10 | $ | 26 | $ | 3 | $ | 215 | ||||||||||||
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Other current assets |
85 | 0 | 0 | 0 | 0 | 85 | ||||||||||||||||||
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Total |
$ | 99 | $ | 162 | $ | 10 | $ | 26 | $ | 3 | $ | 300 | ||||||||||||
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Designated hedge derivatives: |
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Short-term investments |
$ | 6 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 6 | ||||||||||||
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Other current assets |
177 | 0 | 0 | 0 | 0 | 177 | ||||||||||||||||||
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Total |
$ | 183 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 183 | ||||||||||||
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Total assets |
$ | 282 | $ | 162 | $ | 10 | $ | 26 | $ | 3 | $ | 483 | ||||||||||||
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Non-designated hedge derivatives: |
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Other current liabilities |
$ | (84 | ) | $ | (19 | ) | $ | (17 | ) | $ | (21 | ) | $ | 0 | $ | (141 | ) | |||||||
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Designated hedge derivatives: |
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Other current liabilities |
$ | (14 | ) | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | (14 | ) | ||||||||||
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Total liabilities |
$ | (98 | ) | $ | (19 | ) | $ | (17 | ) | $ | (21 | ) | $ | 0 | $ | (155 | ) | |||||||
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See also Note 4 – Investments and Note 6 – Fair Value Measurements.
Fair Value Hedge Gains (Losses)
We recognized in other income (expense) the following gains (losses) on contracts designated as fair value hedges and their related hedged items:
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| Year Ended June 30, | 2013 | 2012 | 2011 | |||||||||
| Foreign Exchange Contracts | ||||||||||||
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Derivatives |
$ | 70 | $ | 52 | $ | (92 | ) | |||||
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Hedged items |
(69 | ) | (50 | ) | 85 | |||||||
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Total |
$ | 1 | $ | 2 | $ | (7 | ) | |||||
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Cash Flow Hedge Gains (Losses)
We recognized the following gains (losses) on foreign exchange contracts designated as cash flow hedges (our only cash flow hedges during the periods presented):
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| Year Ended June 30, | 2013 | 2012 | 2011 | |||||||||
| Effective Portion | ||||||||||||
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Gains (losses) recognized in OCI, net of tax effects of $54, $127 and $(340) |
$ | 101 | $ | 236 | $ | (632 | ) | |||||
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Gains (losses) reclassified from AOCI into revenue |
$ | 195 | $ | (27 | ) | $ | (7 | ) | ||||
| Amount Excluded from Effectiveness Assessment and Ineffective Portion | ||||||||||||
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Losses recognized in other income (expense) |
$ | (168 | ) | $ | (231 | ) | $ | (276 | ) | |||
We estimate that $95 million of net derivative gains included in AOCI at June 30, 2013 will be reclassified into earnings within the following 12 months. No significant amounts of gains (losses) were reclassified from AOCI into earnings as a result of forecasted transactions that failed to occur during fiscal year 2013.
Non-Designated Derivative Gains (Losses)
Gains (losses) from changes in fair values of derivatives that are not designated as hedges are primarily recognized in other income (expense). These amounts are shown in the table below, with the exception of gains (losses) on derivatives presented in income statement line items other than other income (expense), which were immaterial for the periods presented. Other than those derivatives entered into for investment purposes, such as commodity contracts, the gains (losses) below are generally economically offset by unrealized gains (losses) in the underlying available-for-sale securities.
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| Year Ended June 30, | 2013 | 2012 | 2011 | |||||||||
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Foreign exchange contracts |
$ | 18 | $ | (119 | ) | $ | (27 | ) | ||||
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Equity contracts |
16 | (85 | ) | 35 | ||||||||
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Interest-rate contracts |
(11 | ) | 93 | 19 | ||||||||
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Credit contracts |
(3 | ) | (7 | ) | 24 | |||||||
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Commodity contracts |
(42 | ) | (121 | ) | 148 | |||||||
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Total |
$ | (22 | ) | $ | (239 | ) | $ | 199 | ||||
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