N O T E S T O T H E F I N A N C I A L S T A T E M E N T S
| 4. Financial Instruments
Strategy and Risk The Corporation and its subsidiaries use derivative financial instruments in limited instances for purposes other than trading to manage risk related to changes in fuel prices and interest rates. The Corporation uses swaps, futures and/or forward contracts to mitigate the downside risk of adverse price and rate movements and hedge the exposure to variable cash flows. However, the use of these instruments also limits future gains from favorable movements.
Market and Credit Risk The Corporation addresses market risk related to these instruments by selecting instruments whose value fluctuations highly correlate with the underlying item being hedged. Credit risk related to derivative financial instruments, which is minimal, is managed by requiring high credit standards for counterparties and periodic settlements. The total credit risk associated with the Corporation's counterparties was $2 million and $79 million at December 31, 2000 and December 31, 1999, respectively. The Corporation has not been required to provide collateral; however, the Corporation has received collateral relating to its hedging activity where the concentration of credit risk was substantial.
In addition, the Corporation enters into secured financings in which the debtor has pledged collateral. The collateral is based upon the nature of the financing and the credit risk of the debtor. The Corporation generally is not permitted to sell or repledge the collateral unless the debtor defaults.
Determination of Fair Value The fair values of the Corporation's derivative financial instrument positions at December 31, 2000 and 1999, as follows, were determined based upon current fair values as quoted by recognized dealers or developed based upon the present value of expected future cash flows discounted at the applicable U.S. Treasury rate and swap spread.
Interest Rate Strategy The Corporation manages its overall exposure to fluctuations in interest rates by adjusting the proportion of fixed- and floating-rate debt instruments within its debt portfolio over a given period. The mix of fixed- and floating-rate debt is largely managed through the issuance of targeted amounts of each as debt matures or as incremental borrowings are required. Derivatives are used in limited circumstances as one of the tools to obtain the targeted mix. In addition, the Corporation also obtains additional flexibility in managing interest costs and the interest rate mix within its debt portfolio by issuing callable fixed-rate debt securities.
Fuel Strategy Fuel costs are a significant portion of the Corporation's total operating expenses. As a result of the significance of fuel costs and the historical volatility of fuel prices, the Corporation's transportation subsidiaries periodically use swaps, futures and/or forward contracts to mitigate the impact of adverse fuel price changes. The following is a summary of the Corporation's financial instruments at December 31, 2000 and 1999:
The asset and liability positions of the Corporation's outstanding financial instruments at December 31, 2000 and 1999 were as follows:
The Corporation's use of derivative financial instruments had the following impact on pre-tax income for the years ended December 31, 2000, 1999 and 1998:
Fair Value of Debt Instruments The fair value of the Corporation's long- and short-term debt has been estimated using quoted market prices or current borrowing rates. At December 31, 2000 and 1999, the fair value of total debt was more (less) than the carrying value by approximately $56 million and $(160) million, respectively. At both December 31, 2000 and 1999, approximately $1.3 billion of fixed-rate debt securities contain call provisions that allow the Corporation to retire the debt instruments prior to final maturity subject, in certain cases, to the payment of premiums.
Sale of Receivables The Railroad has sold, on a revolving basis, an undivided percentage ownership interest in a designated pool of accounts receivable to third parties through a bankruptcy-remote subsidiary. Receivables are sold at carrying value, which approximates fair value. The third parties have designated the Railroad to service the sold receivables. The amount of receivables sold fluctuates based upon the availability of the designated pool of receivables and is directly affected by changing business volumes and credit risks. At December 31, 2000 and 1999, accounts receivable are presented net of $600 million and $576 million, respectively, of receivables sold.
|3. Divestitures | 5. Properties|