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| Annual Report 1996 | ||
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| Annual Report 1996 | ||
Foreign Currency Exchange
The Company generates a substantial portion of its revenues in international markets, which subjects its operations to the exposure of foreign currency fluctuations. The impact of currency fluctuations can be positive or negative in any given period. The Company's ability to counteract foreign currency exchange movement is primarily dependent on pricing.
To minimize the adverse impact of foreign currency fluctuations on its foreign currency-denominated net assets, the Company may engage in foreign currency-denominated borrowings. The Company determines the aggregate amount of such borrowings based on its forecast of the Company's net asset position and the relative strength of the U.S. dollar as compared to foreign currencies. These borrowings create foreign currency-denominated liabilities that hedge the Company's foreign currency-denominated net assets. Upon receipt of the borrowed foreign currency-denominated funds, the Company converts those funds to U.S. dollars at the spot exchange rate. Exchange gains and losses on the foreign currency-denominated borrowings are recognized in earnings as incurred. At December 31, 1996 and 1995, the amount of the Company's outstanding short-term foreign currency-denominated borrowings were $123 million and $140 million, respectively.
From time to time, the Company may use over-the-counter foreign exchange swaps to reduce the interest expense incurred on its overseas borrowings. When a foreign exchange swap is used, the currency received by the Company in the spot market component of the foreign exchange swap is used to close out borrowings in a similar currency and, simultaneously, the original borrowing position is reinstituted through a forward contract (not exceeding six months). The net interest value of the foreign exchange swap contract is amortized to earnings over the life of the contract. Exchange gains or losses on the foreign currency component of the forward contract are recognized in earnings as incurred in each accounting period. The Company does not enter into foreign exchange swaps for trading purposes. There were no foreign exchange swap contracts outstanding at December 31, 1996. The aggregate notional value of the Company's short-term foreign exchange swap contracts was $16 million at December 31, 1995.
When the Company may not have sufficient flexibility to increase prices in local currency to reflect any appreciation of the U.S. dollar, the Company may, from time to time, also purchase U.S. dollar call options. The term of these call options typically does not exceed one year. The Company's purchase of call options allows it to protect a portion of its expected foreign currency-denominated revenues from adverse foreign currency exchange movement. The Company does not buy call options which can be exercised prior to the expiration date, nor does it write options or purchase call options for trading purposes. The Company defers premiums and any gains for its call options activity until the option exercise date. No option contracts were outstanding at December 31, 1996 and 1995.
The Company maintains a Monetary Control Center (the MCC), which operates under written policies and procedures defining day-to-day operating guidelines, including exposure limits, to contract for the foreign currency-denominated borrowings, foreign exchange swaps and call options described above. The MCC is subject to random independent audits and reports to a supervisory committee comprised of members of the Company's management. The MCC publishes monthly reports to the Company's management detailing the foreign currency activities it has engaged in for the prior month.
