Note 5.    Derivative Financial Instruments

We enter into foreign currency contracts with financial institutions to reduce the risk that our cash flows and earnings will be adversely affected by foreign currency exchange rate fluctuations. We use certain interest rate derivative contracts to hedge interest rate exposures on our fixed income securities. Our program is not designated for trading or speculative purposes.

We recognize derivative instruments as either assets or liabilities on the accompanying Consolidated Balance Sheets at fair value. We record changes in the fair value (i.e., gains or losses) of the derivatives in the accompanying Consolidated Statements of Income as interest and other income, net, as part of revenues, or to accumulated other comprehensive income (AOCI) in the accompanying Consolidated Balance Sheets.

Cash Flow Hedges

We use options designated as cash flow hedges to hedge certain forecasted revenue transactions denominated in currencies other than the U.S. dollar. We initially report any gain on the effective portion of a cash flow hedge as a component of AOCI and subsequently reclassify to revenues when the hedged revenues are recorded or as interest and other income, net, if the hedged transaction becomes probable of not occurring. Further, we exclude the change in the time value of the options from our assessment of hedge effectiveness. We record the premium paid or time value of an option on the date of purchase as an asset. Thereafter, we recognize any change to this time value in interest and other income, net.

At December 31, 2011, the effective portion of our cash flow hedges before tax effect was $154 million, of which $127 million is expected to be reclassified from AOCI to revenues within the next 12 months.

The notional principal of foreign exchange contracts to purchase U.S. dollars with Euros was €3.0 billion (or approximately $4.1 billion) and €2.8 billion (or approximately $3.8 billion) at December 31, 2010 and December 31, 2011; the notional principal of foreign exchange contracts to purchase U.S. dollars with British pounds was £1.5 billion (or approximately $2.3 billion) and £1.4 billion (or approximately $2.2 billion) at December 31, 2010 and December 31, 2011; and the notional principal of foreign exchange contracts to purchase U.S. dollars with Canadian dollars was C$407 million (or approximately $382 million) and C$504 million (or approximately $490 million) at December 31, 2010 and December 31, 2011. These foreign exchange contracts have maturities of 36 months or less.

Fair Value Hedges

We use forward contracts designated as fair value hedges to hedge foreign currency risks for our investments denominated in currencies other than the U.S. dollar. Gains and losses on these contracts are recognized in interest and other income, net, along with the offsetting losses and gains of the related hedged items. We exclude changes in the time value for forward contracts from the assessment of hedge effectiveness and recognize them in interest and other income, net. The notional principal of foreign exchange contracts to purchase U.S. dollars with foreign currencies was $787 million and $1.0 billion at December 31, 2010 and December 31, 2011.

Other Derivatives

Other derivatives not designated as hedging instruments consist of forward and option contracts that we use to hedge intercompany transactions and other monetary assets or liabilities denominated in currencies other than the local currency of a subsidiary. We recognize gains and losses on these contracts as well as the related costs in interest and other income, net, along with the gains and losses of the related hedged items. The notional principal of foreign exchange contracts to purchase U.S. dollars with foreign currencies was $1.0 billion and $2.3 billion at December 31, 2010 and December 31, 2011. The notional principal of foreign exchange contracts to sell U.S. dollars for foreign currencies was $84 million and $472 million at December 31, 2010 and December 31, 2011. The notional principal of foreign exchange contracts to purchase Euros with other foreign currencies was €991 million (or approximately $1.3 billion) and €711 million (or approximately $929 million) at December 31, 2010 and December 31, 2011. The notional principal of foreign exchange contracts to sell Euros for other foreign currencies was €6 million (or approximately $8 million) at December 31, 2010 and no such contracts were outstanding at December 31, 2011.

We also use exchange-traded interest rate futures contracts and “To Be Announced” (TBA) forward purchase commitments of mortgage-backed assets to hedge interest rate risks on certain fixed income securities. The TBA contracts meet the definition of derivative instruments in cases where physical delivery of the assets is not taken at the earliest available delivery date. Our interest rate futures and TBA contracts (together interest rate contracts) are not designated as hedging instruments. We recognize gains and losses on these contracts as well as the related costs in interest and other income, net. The gains and losses are generally economically offset by unrealized gains and losses in the underlying available-for-sale securities, which are recorded as a component of AOCI until the securities are sold or other-than-temporarily impaired, at which time the amounts are moved from AOCI into interest and other income, net. As of December 31, 2011, the total notional amounts of interest rate contracts outstanding were $100 million.

 

The fair values of our outstanding derivative instruments were as follows (in millions):

 

		Balance Sheet Location		Fair Value of Derivative Instruments
				As of December 31, 2010				As of December 31, 2011
Derivative Assets
Derivatives designated as hedging instruments:
Foreign exchange contracts		Prepaid revenue share, expenses and other assets, current and non-current		$	342			$	333
Derivatives not designated as hedging instruments:
Foreign exchange contracts		Prepaid revenue share, expenses and other assets, current			0				4
Total				$	342			$	337
Derivative Liabilities
Derivatives designated as hedging instruments:
Foreign exchange contracts		Accrued expenses and other current liabilities		$	5			$	5
Derivatives not designated as hedging instruments:
Foreign exchange contracts		Accrued expenses and other current liabilities			3				1
Total				$	8			$	6

The effect of derivative instruments in cash flow hedging relationships on income and other comprehensive income is summarized below (in millions):

 

		Increase (Decrease) in Gains Recognized in AOCI on Derivatives Before  Tax Effect (Effective Portion)
		Year Ended December 31,
Derivatives in Cash Flow Hedging Relationship		2009				2010				2011
Foreign exchange contracts		$	(14	)		$	331			$	54

 

		Gains Reclassified from AOCI into Income (Effective Portion)
				Year Ended December 31,
Derivatives in Cash Flow Hedging Relationship		Location		2009				2010				2011
Foreign exchange contracts		Revenues		$	325			$	203			$	43

 

		Gains (Losses) Recognized in Income on Derivatives (Amount Excluded from Effectiveness  Testing and Ineffective Portion)(1)
				Year Ended December 31,
Derivatives in Cash Flow Hedging Relationship		Location		2009				2010				2011
Foreign exchange contracts		Interest and other income, net		$	(268	)		$	(320	)		$	(323	)

 

1	Gains (losses) related to the ineffective portion of the hedges were not material in all periods presented.

 

The effect of derivative instruments in fair value hedging relationships on income is summarized below (in millions):

 

		Gains (Losses) Recognized in Income on Derivatives(2)
				Year Ended December 31,
Derivatives in Fair Value Hedging Relationship		Location		2009				2010				2011
Foreign exchange contracts		Interest and other income, net		$	2			$	(35	)		$	(2	)
Hedged item		Interest and other income, net			(2	)			29				(12	)
Total				$	0			$	(6	)		$	(14	)

 

2	Losses related to the amount excluded from effectiveness testing of the hedges were $0, $6 million, and $14 million for the years ended December 31, 2009, December 31, 2010, and December 31, 2011.

The effect of derivative instruments not designated as hedging instruments on income is summarized below (in millions):

 

		Gains (Losses) Recognized in Income on Derivatives
				Year Ended December 31,
Derivatives Not Designated As Hedging Instruments		Location		2009				2010				2011
Foreign exchange contracts		Interest and other income, net		$	(78	)		$	(40	)		$	29
Interest rate contracts		Interest and other income, net			0				0				(19	)
				$	(78	)		$	(40	)		$	10