Quarterly report pursuant to Section 13 or 15(d)

Derivative Financial Instruments

v3.2.0.727
Derivative Financial Instruments
 6 Months Ended
Jun. 27, 2015
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Financial Instruments [Text Block]
Note 6: Derivative Financial Instruments
Our primary objective for holding derivative financial instruments is to manage currency exchange rate risk and interest rate risk, and, to a lesser extent, equity market risk, commodity price risk, and credit risk. When possible, we enter into master netting arrangements with counterparties to mitigate credit risk in derivative transactions. A master netting arrangement may allow counterparties to net settle amounts owed to each other as a result of multiple, separate derivative transactions. Generally, our master netting agreements allow for net settlement in case of certain triggering events such as bankruptcy or default of one of the counterparties to the transaction. We may also elect to exchange cash collateral with certain of our counterparties on a regular basis. For presentation on our consolidated condensed balance sheets, we do not offset fair value amounts recognized for derivative instruments under master netting arrangements. Our derivative financial instruments are recorded at fair value and are included in other current assets, other long-term assets, other accrued liabilities, or other long-term liabilities.
Currency Exchange Rate Risk
We are exposed to currency exchange rate risk, and generally hedge our exposures with currency forward contracts, currency interest rate swaps, or currency options. Substantially all of our revenue is transacted in U.S. dollars. However, a significant amount of our operating expenditures and capital purchases is incurred in or exposed to other currencies, primarily the euro, the Chinese yuan, the Japanese yen, and the Israeli shekel. We have established balance sheet and forecasted transaction currency risk management programs to protect against fluctuations in the fair value and the volatility of the functional currency equivalent of future cash flows caused by changes in exchange rates. Our non-U.S.-dollar-denominated investments in debt instruments and loans receivable are generally hedged with offsetting currency forward contracts or currency interest rate swaps. We may also hedge currency risk arising from funding foreign currency denominated forecasted investments. These programs reduce, but do not eliminate, the impact of currency exchange movements.
Our currency risk management programs include:
•
Currency derivatives with cash flow hedge accounting designation that utilize currency forward contracts and currency options to hedge exposures to the variability in the U.S.-dollar equivalent of anticipated non-U.S.-dollar-denominated cash flows. These instruments generally mature within 12 months. For these derivatives, we report the after-tax gain or loss from the effective portion of the hedge as a component of accumulated other comprehensive income (loss), and we reclassify it into earnings in the same period or periods in which the hedged transaction affects earnings, and in the same line item on the consolidated condensed statements of income as the impact of the hedged transaction.
•
Currency derivatives without hedge accounting designation that utilize currency forward contracts or currency interest rate swaps to economically hedge the functional currency equivalent cash flows of recognized monetary assets and liabilities, non-U.S.-dollar-denominated debt instruments classified as trading assets, and hedges of non-U.S.-dollar-denominated loans receivable are recognized at fair value. The substantial majority of these mature within 12 months. Changes in the functional currency equivalent cash flows of the underlying assets and liabilities are approximately offset by the changes in the fair value of the related derivatives. We record net gains or losses in the line item on the consolidated condensed statements of income most closely associated with the related exposures, primarily in interest and other, net, except for equity-related gains or losses, which we primarily record in gains (losses) on equity investments, net.
Interest Rate Risk
Our primary objective for holding investments in debt instruments is to preserve principal while maximizing yields. We generally swap the returns on our investments in fixed-rate debt instruments with remaining maturities longer than six months into U.S. dollar three-month LIBOR-based returns, unless management specifically approves otherwise. These swaps are settled at various interest payment times involving cash payments at each interest and principal payment date, with the majority of the contracts having quarterly payments.
Our interest rate risk management programs include:
•
Interest rate derivatives with cash flow hedge accounting designation that utilize interest rate swap agreements to modify the interest characteristics of debt instruments. For these derivatives, we report the after-tax gain or loss from the effective portion of the hedge as a component of accumulated other comprehensive income (loss), and we reclassify it into earnings in the same period or periods in which the hedged transaction affects earnings, and in the same line item on the consolidated condensed statements of income as the impact of the hedged transaction.
•
Interest rate derivatives without hedge accounting designation that utilize interest rate swaps and currency interest rate swaps in economic hedging transactions, including hedges of non-U.S.-dollar-denominated debt instruments classified as trading assets and hedges of non-U.S.-dollar-denominated loans receivable recognized at fair value. Floating interest rates on the swaps generally reset on a quarterly basis. Changes in fair value of the debt instruments classified as trading assets and loans receivable recognized at fair value are generally offset by changes in the fair value of the related derivatives, both of which are recorded in interest and other, net.
Equity Market Risk
Our investments include marketable equity securities and equity derivative instruments. We typically do not attempt to reduce or eliminate our equity market exposure through hedging activities at the inception of our investments. Before we enter into hedge arrangements, we evaluate legal, market, and economic factors, as well as the expected timing of disposal to determine whether hedging is appropriate. Our equity market risk management program may include equity derivatives with or without hedge accounting designation that utilize warrants, equity options, or other equity derivatives. We recognize changes in the fair value of such derivatives in gains (losses) on equity investments, net. We also utilize total return swaps to offset changes in liabilities related to the equity market risks of certain deferred compensation arrangements. Gains and losses from changes in fair value of these total return swaps are generally offset by the losses and gains on the related liabilities, both of which are recorded in cost of sales and operating expenses.
Volume of Derivative Activity
Total gross notional amounts for outstanding derivatives (recorded at fair value) at the end of each period were as follows: 
(In Millions)
 
Jun 27,
2015
 
Dec 27,
2014
 
Jun 28,
2014
Currency forwards
 
$
12,051

 
$
15,578

 
$
12,212

Currency interest rate swaps
 
4,789

 
5,446

 
4,908

Embedded debt derivatives
 
3,600

 
3,600

 
3,600

Interest rate swaps
 
1,006

 
1,347

 
1,318

Total return swaps
 
1,107

 
1,056

 
1,040

Other
 
72

 
49

 
61

Total
 
$
22,625

 
$
27,076

 
$
23,139

The gross notional amounts for currency forwards and currency interest rate swaps (presented by currency) at the end of each period were as follows:
(In Millions)
 
Jun 27,
2015
 
Dec 27,
2014
 
Jun 28,
2014
Chinese yuan
 
$
3,380

 
$
3,097

 
$
1,498

Euro
 
6,193

 
7,486

 
5,942

Israeli shekel
 
1,632

 
2,489

 
1,995

Japanese yen
 
2,846

 
3,779

 
3,188

Other
 
2,789

 
4,173

 
4,497

Total
 
$
16,840

 
$
21,024

 
$
17,120


During the fourth quarter of 2014, we entered into $1.5 billion of forward contracts to hedge our anticipated equity funding of the Tsinghua Unigroup investment. The hedges were designated as cash flow hedges and the related gains and losses attributable to changes in the spot rates will be recognized in accumulated other comprehensive income (loss) until the Tsinghua Unigroup shares are either disposed of or impaired. As the shares are either disposed of or impaired, we will reclassify the gains or losses from accumulated other comprehensive income (loss) to gains (losses) on equity investments, net as an offset to the gain or loss recognized for the share disposal or impairment. Hedge gains and losses attributable to changes in the forward rates will be recognized in interest and other, net. During the second quarter of 2015, we discontinued cash flow hedge accounting treatment for $478 million of forward contracts since we could no longer assert that funding is probable to occur within the initially specified timeline. Hedge losses accumulated in other comprehensive income related to these de-designated forward contracts are insignificant.
Fair Value of Derivative Instruments in the Consolidated Condensed Balance Sheets
The fair value of our derivative instruments at the end of each period were as follows:
 
 
June 27, 2015
 
December 27, 2014
(In Millions)
 
Other
Current
Assets
 
Other
Long-Term
Assets
 
Other
Accrued
Liabilities
 
Other
Long-Term
Liabilities
 
Other
Current
Assets
 
Other
Long-Term
Assets
 
Other
Accrued
Liabilities
 
Other
Long-Term
Liabilities
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Currency forwards
 
$
50

 
$
4

 
$
276

 
$
4

 
$
6

 
$
1

 
$
497

 
$
9

Total derivatives designated as hedging instruments
 
50

 
4

 
276

 
4

 
6

 
1

 
497

 
9

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Currency forwards
 
89

 
—

 
83

 
—

 
207

 
—

 
44

 
—

Currency interest rate swaps
 
344

 
54

 
35

 
—

 
344

 
34

 
7

 
—

Embedded debt derivatives
 
—

 
—

 
—

 
17

 
—

 
—

 
4

 
8

Interest rate swaps
 
1

 
—

 
4

 
—

 
3

 
—

 
11

 
—

Other
 
2

 
16

 
6

 
—

 
1

 
22

 
—

 
—

Total derivatives not designated as hedging instruments
 
436

 
70

 
128

 
17

 
555

 
56

 
66

 
8

Total derivatives
 
$
486

 
$
74

 
$
404

 
$
21

 
$
561

 
$
57

 
$
563

 
$
17



Amounts Offset in the Consolidated Condensed Balance Sheets
The gross amounts of our derivative instruments and reverse repurchase agreements subject to master netting arrangements with various counterparties and cash and non-cash collateral posted under such agreements at the end of each period were as follows:
 
 
June 27, 2015
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Balance Sheet
 
 
(In Millions)
 
Gross Amounts Recognized
 
Gross Amounts Offset in the Balance Sheet
 
Net Amounts Presented in the Balance Sheet
 
Financial Instruments
 
Cash and Non-Cash Collateral Received or Pledged
 
Net Amount
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
Derivative assets subject to master netting arrangements
 
$
540

 
$
—

 
$
540

 
$
(293
)
 
$
(178
)
 
$
69

Reverse repurchase agreements
 
768

 
—

 
768

 
—

 
(768
)
 
—

Total assets
 
1,308

 
—

 
1,308

 
(293
)
 
(946
)
 
69

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Derivative liabilities subject to master netting arrangements
 
413

 
—

 
413

 
(293
)
 
(48
)
 
72

Total liabilities
 
$
413

 
$
—

 
$
413

 
$
(293
)
 
$
(48
)
 
$
72

 
 
December 27, 2014
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Balance Sheet
 
 
(In Millions)
 
Gross Amounts Recognized
 
Gross Amounts Offset in the Balance Sheet
 
Net Amounts Presented in the Balance Sheet
 
Financial Instruments
 
Cash and Non-Cash Collateral Received or Pledged
 
Net Amount
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
Derivative assets subject to master netting arrangements
 
$
559

 
$
—

 
$
559

 
$
(365
)
 
$
(78
)
 
$
116

Reverse repurchase agreements
 
718

 
—

 
718

 
—

 
(718
)
 
—

Total assets
 
1,277

 
—

 
1,277

 
(365
)
 
(796
)
 
116

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Derivative liabilities subject to master netting arrangements
 
559

 
—

 
559

 
(365
)
 
(80
)
 
114

Total liabilities
 
$
559

 
$
—

 
$
559

 
$
(365
)
 
$
(80
)
 
$
114


Derivatives in Cash Flow Hedging Relationships
The before-tax gains (losses), attributed to the effective portion of cash flow hedges, recognized in other comprehensive income (loss) for each period were as follows:
 
 
Three Months Ended
 
Six Months Ended
(In Millions)
 
Jun 27,
2015
 
Jun 28,
2014
 
Jun 27,
2015
 
Jun 28,
2014
Currency forwards
 
$
29

 
$
5

 
$
(200
)
 
$
40

Other
 
—

 
(1
)
 
—

 
(3
)
Total
 
$
29

 
$
4

 
$
(200
)
 
$
37


Gains and losses on derivative instruments in cash flow hedging relationships related to hedge ineffectiveness and amounts excluded from effectiveness testing, were insignificant during all periods presented in the preceding tables. Additionally, for all periods presented, there was an insignificant impact on results of operations from discontinued cash flow hedges, which arises when forecasted transactions are probable of not occurring.
For information on the unrealized holding gains (losses) on derivatives reclassified out of accumulated other comprehensive income into the consolidated condensed statements of income, see "Note 20: Other Comprehensive Income (Loss)."
Derivatives Not Designated as Hedging Instruments
The effects of derivative instruments not designated as hedging instruments on the consolidated condensed statements of income for each period were as follows:
 
 
 
 
Three Months Ended
 
Six Months Ended
(In Millions)
 
Location of Gains (Losses)
Recognized in Income on Derivatives
 
Jun 27,
2015
 
Jun 28,
2014
 
Jun 27,
2015
 
Jun 28,
2014
Currency forwards
 
Interest and other, net
 
$
4

 
$
(7
)
 
$
(14
)
 
$
(22
)
Currency interest rate swaps
 
Interest and other, net
 
(50
)
 
26

 
203

 
(28
)
Interest rate swaps
 
Interest and other, net
 
1

 
(4
)
 
(5
)
 
(4
)
Total return swaps
 
Various
 
11

 
45

 
42

 
58

Other
 
Various
 
(5
)
 
1

 
(14
)
 
2

Total
 
 
 
$
(39
)
 
$
61

 
$
212

 
$
6