Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
All market risk sensitive instruments were entered into for non-trading purposes.
Foreign Currency Risk
Foreign Currency Exposures and Hedging Instruments
In countries outside the United States, we transact business in U.S. Dollars and various other currencies, which subject us to exposure from movements in exchange rates. We may use foreign exchange option contracts or forward contracts to hedge a portion of our forecasted foreign currency denominated revenue. Additionally, we hedge our net recognized foreign currency monetary assets and liabilities with foreign exchange forward contracts to reduce the risk that our earnings and cash flows will be adversely affected by changes in exchange rates.
Our significant foreign currency revenue exposures for fiscal 2020, 2019 and 2018 were as follows :
(in millions) 2020 2019 2018
Euro € 1,887 € 1,603 € 1,310
Japanese Yen ¥ 88,640 ¥ 73,158 ¥ 60,791
British Pounds £ 562 £ 503 £ 423
Australian Dollars $ 645 $ 538 $ 441
As of November 27, 2020, the total notional amounts of all outstanding foreign exchange contracts, including options and forwards, was $2.03 billion, which included the notional equivalent of $923 million in Euros, $385 million in Japanese Yen, $321 million in British Pounds, $212 million in Australian Dollars and $186 million in other foreign currencies. As of November 27, 2020, all contracts were set to expire at various dates through June 2021. The bank counterparties in these contracts could expose us to credit-related losses that would be largely mitigated with master netting arrangements with the same counterparty by permitting net settlement transactions. In addition, we enter into collateral security agreements that
58
Table of Contents
provide for collateral to be received or posted when the net fair value of these contracts fluctuates from contractually established thresholds.
A sensitivity analysis was performed on all of our foreign exchange derivatives as of November 27, 2020. This sensitivity analysis measures the hypothetical market value resulting from a 10% shift in the value of exchange rates relative to the U.S. Dollar. For option contracts, the Black-Scholes option pricing model was used. A 10% increase in the value of the U.S. Dollar and a corresponding decrease in the value of the hedged foreign currency asset would lead to an increase in the fair value of our financial hedging instruments by $97 million. Conversely, a 10% decrease in the value of the U.S. Dollar would result in a decrease in the fair value of these financial instruments by $9 million.
As a general rule, we do not use foreign exchange contracts to hedge local currency denominated operating expenses in countries where a natural hedge exists. For example, in many countries, revenue in the local currencies substantially offsets the local currency denominated operating expenses. We also have long-term investment exposures consisting of the capitalization and retained earnings in our non-U.S. Dollar functional currency foreign subsidiaries. As of November 27, 2020 and November 29, 2019, this long-term investment exposure totaled an absolute notional equivalent of $598 million and $385 million, respectively, with the year-over-year increase primarily driven by earnings growth. At this time, we do not hedge these long-term investment exposures.
We do not use foreign exchange contracts for speculative trading purposes, nor do we hedge our foreign currency exposure in a manner that entirely offsets the effects of changes in foreign exchange rates. We regularly review our hedging program and assess the need to utilize financial instruments to hedge currency exposures on an ongoing basis.
Cash Flow Hedges of Forecasted Foreign Currency Revenue
We may use foreign exchange purchased options or forward contracts to hedge foreign currency revenue denominated in Euros, British Pounds, Japanese Yen and Australian Dollars. We hedge these cash flow exposures to reduce the risk that our earnings and cash flows will be adversely affected by changes in exchange rates. These foreign exchange contracts, carried at fair value, have maturities of up to twelve months. We enter into these foreign exchange contracts to hedge forecasted revenue in the normal course of business and accordingly, they are not speculative in nature.
We record changes in fair value of these cash flow hedges of foreign currency denominated revenue in accumulated other comprehensive income (loss) in our Consolidated Balance Sheets, until the forecasted transaction occurs. When the forecasted transaction affects earnings, we reclassify the related gain or loss on the cash flow hedge to revenue. In the event the underlying forecasted transaction does not occur, or it becomes probable that it will not occur, we reclassify the gain or loss on the related cash flow hedge from accumulated other comprehensive income (loss) to revenue. For the fiscal year ended November 27, 2020, there were no net gains or losses recognized in revenue relating to hedges of forecasted transactions that did not occur.
Non-Designated Hedges of Foreign Currency Assets and Liabilities
Our derivatives not designated as hedging instruments consist of foreign currency forward contracts that we primarily use to hedge monetary assets and liabilities denominated in non-functional currencies to reduce the risk that our earnings and cash flows will be adversely affected by changes in foreign currency exchange rates. These foreign exchange contracts are carried at fair value with changes in fair value of these contracts recorded to other income (expense), net in our Consolidated Statements of Income. These contracts reduce the impact of currency exchange rate movements on our assets and liabilities. At November 27, 2020, the outstanding balance sheet hedging derivatives had maturities of 180 days or less.
See Note 6 of our Notes to Consolidated Financial Statements for information regarding our derivative financial instruments.
59
Table of Contents
Interest Rate Risk
Short-Term Investments and Fixed Income Securities
At November 27, 2020, we had debt securities classified as short-term investments of $1.51 billion. Changes in interest rates could adversely affect the market value of these investments. A sensitivity analysis was performed on our investment portfolio as of November 27, 2020. The analysis is based on an estimate of the hypothetical changes in market value of the portfolio that would result from an immediate parallel shift in the yield curve of various magnitudes.
The following tables present the hypothetical fair values of our debt securities classified as short-term investments assuming immediate parallel shifts in the yield curve of 50 basis points (“BPS”), 100 BPS and 150 BPS. The analysis is shown as of November 27, 2020 and November 29, 2019:
(dollars in millions)
-150 BPS -100 BPS -50 BPS Fair Value 11/27/20
+50 BPS +100 BPS +150 BPS
$ 1,521 $ 1,520 $ 1,519 $ 1,514 $ 1,507 $ 1,500 $ 1,493
-150 BPS -100 BPS -50 BPS Fair Value 11/29/19
+50 BPS +100 BPS +150 BPS
$ 1,545 $ 1,539 $ 1,533 $ 1,527 $ 1,521 $ 1,515 $ 1,509
Senior Notes
Following our debt refinancing in February 2020, our outstanding Notes have fixed interest rates. As of November 27, 2020, the total carrying amount of our Notes was $4.12 billion and the related fair value based on observable market prices in less active markets was $4.48 billion.
See Note 17 of our Notes to Consolidated Financial Statements for information regarding our senior notes.
60
Table of Contents