ITEM 7A. Quantitative
and Qualitative Disclosures about Market Risk
We are exposed to foreign currency,
interest rate, and fixed income and equity price risks. A portion of these
risks is hedged, but fluctuations could impact our results of operations and
financial position. We hedge a portion of anticipated revenue and accounts
receivable exposure to foreign currency fluctuations, primarily with option
contracts. We monitor our foreign currency exposures daily to maximize the
overall effectiveness of our foreign currency hedge positions. Principal
currencies hedged include the Euro, Japanese yen, British pound, and Canadian
dollar. Fixed income securities are subject to interest rate risk. The
portfolio is diversified and structured to minimize credit risk. We routinely
use options to hedge a portion of our exposure to interest rate risk in the
event of a catastrophic increase in interest rates. Securities held in our
equity and other investments portfolio are subject to price risk, and are
generally not hedged. However, we use options to hedge our price risk on
certain highly volatile equity securities that are held primarily for strategic
purposes.
We use a value-at-risk (VAR) model to
estimate and quantify our market risks. VAR is the expected loss, for a given confidence
level, in fair value of our portfolio due to adverse market movements over a
defined time horizon. The VAR model is not intended to represent actual losses
in fair value, but is used as a risk estimation and management tool. The model
used for currencies and equities is geometric Brownian motion, which allows
incorporation of optionality with regard to these risk exposures. For interest
rate risk, the mean reverting geometric Brownian motion is used to reflect the
principle that fixed-income securities prices revert to maturity value over
time.
Value-at-risk is calculated by,
first, simulating 10,000 market price paths over 20 days for equities, interest
rates and foreign exchange rates, taking into account historical correlations
among the different rates and prices. Each resulting unique set of equities
prices, interest rates, and foreign exchange rates is applied to substantially
all individual holdings to re-price each holding. The 250th worst
performance (out of 10,000) represents the value-at-risk over 20 days at the
97.5th percentile confidence level. Several risk factors are not
captured in the model, including liquidity risk, operational risk, credit risk,
and legal risk.
Certain securities in our equity
portfolio are held for strategic purposes. We hedge the value of a portion of
these securities through the use of derivative contracts such as put-call
collars. In these arrangements, we hedge a security's market risk below the
purchased put strike and forgo most or all of the benefits of the security's
appreciation above the sold call strike, in exchange for premium received for
the sold call. We also hold equity securities for general investment return
purposes. We have incurred material impairment charges related to these
securities. The VAR amounts disclosed below are used as a risk management tool
and reflect an estimate of potential reductions in fair value of our portfolio.
Losses in fair value over a 20-day holding period can exceed the reported VAR
by significant amounts and can also accumulate over a longer time horizon than
the 20-day holding period used in the VAR analysis. VAR amounts are not
necessarily reflective of potential accounting losses, including determinations
of other-than-temporary losses in fair value in accordance with U.S. GAAP.
The VAR numbers are shown separately
for interest rate, currency, and equity risks. These VAR numbers include the
underlying portfolio positions and related hedges. We use historical data to
estimate VAR. Given reliance on historical data, VAR is most effective in
estimating risk exposures in markets in which there are no fundamental changes
or shifts in market conditions. An inherent limitation in VAR is that the
distribution of past changes in market risk factors may not produce accurate predictions
of future market risk.
