Annual Report 2000

Financial Review - Market Risk Disclosure


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Quantitative and Qualititative Disclosures about Market Risk

We maintain an investment portfolio of various holdings, types, and maturities. These securities are generally classified as available for sale and, consequently, are recorded on the balance sheet at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income, net of tax. Part of this portfolio includes minority equity investments in several publicly traded companies, the values of which are subject to market price volatility. For example, as a result of recent market price volatility of our publicly traded equity investments, we experienced a $111 million after-tax unrealized loss during the third quarter of fiscal 2000 and a $1.83 billion after-tax unrealized gain during the fourth quarter of fiscal 2000 on these investments. We have also invested in numerous privately held companies, many of which can still be considered in the start-up or development stages. These investments are inherently risky as the market for the technologies or products they have under development are typically in the early stages and may never materialize. We could lose our entire initial investment in these companies. We also have certain real estate lease commitments with payments tied to short-term interest rates. At any time, a sharp rise in interest rates could have a material adverse impact on the fair value of our investment portfolio while increasing the costs associated with our lease commitments. Conversely, declines in interest rates could have a material impact on interest earnings for our investment portfolio. We do not currently hedge these interest rate exposures.

INVESTMENTS
The following table presents the hypothetical changes in fair values in the financial instruments held at July 29, 2000 that are sensitive to changes in interest rates. These instruments are not leveraged and are held for purposes other than trading. The modeling technique used measures the change in fair values arising from selected potential changes in interest rates. Market changes reflect immediate hypothetical parallel shifts in the yield curve of plus or minus 50 basis points ("BPS"), 100 BPS, and 150 BPS over a 12-month horizon. Beginning fair values represent the principal plus accrued interest and dividends of the interest rate-sensitive financial instruments at July 29, 2000. Ending fair values are the market principal plus accrued interest, dividends, and reinvestment income at a 12-month horizon. The following table estimates the fair value of the portfolio at a 12-month horizon (in millions):



A 50 BPS move in the Federal Funds Rate has occurred in nine of the last 10 years; a 100 BPS move in the Federal Funds Rate has occurred in six of the last 10 years; and a 150 BPS move in the Federal Funds Rate has occurred in four of the last 10 years.

The following analysis presents the hypothetical changes in fair values of public equity investments that are sensitive to changes in the stock market. These equity securities are held for purposes other than trading. The modeling technique used measures the hypothetical change in fair values arising from selected hypothetical changes in each stock's price. Stock price fluctuations of plus or minus 15%, plus or minus 35%, and plus or minus 50% were selected based on the probability of their occurrence. The following table estimates the fair value of the publicly traded corporate equities at a 12-month horizon (in millions):



Our equity portfolio consists of securities with characteristics that most closely match the S&P Index or companies traded on the NASDAQ National Market. The NASDAQ Composite Index has shown a 15% movement in each of the last three years and a 35% and 50% movement in at least one of the last three years.

We also have an investment in KPMG Consulting, Inc. in the principal amount of $1.05 billion of Series A Mandatorily Redeemable Convertible Preferred Stock, which carries a 6% dividend rate on the original issue price until converted to common stock. Conversion is at our option upon or after the completion of an initial public offering of KPMG Consulting, Inc. We have not included the investment in the above sensitivity analyses due to the nature of this investment.

LEASES
We are exposed to interest rate risk associated with leases on our facilities where payments are tied to the London Interbank Offered Rate ("LIBOR"). We have evaluated the hypothetical change in lease obligations held at July 29, 2000 due to changes in the LIBOR. The modeling technique used measures hypothetical changes in lease obligations arising from selected hypothetical changes in the LIBOR. The hypothetical market changes reflected immediate parallel shifts in the LIBOR curve of plus or minus 50 BPS, 100 BPS, and 150 BPS over a 12-month period. The results of this analysis were not material in comparison to our financial results.

FOREIGN EXCHANGE FORWARD AND OPTION CONTRACTS
We enter into foreign exchange forward contracts to offset the impact of currency fluctuations on certain nonfunctional currency assets and liabilities, primarily denominated in Australian, Canadian, Japanese, Korean, and several European currencies, primarily the euro and British pound. We also periodically hedge anticipated transactions with purchased currency options.

The foreign exchange forward and option contracts we enter into generally have original maturities ranging from one to three months. We do not enter into foreign exchange forward and option contracts for trading purposes. We do not expect gains or losses on these contracts to have a material impact on our financial results (see Note 8 to the Consolidated Financial Statements).

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