Altria 2007 Annual Report - Financial Review - Notes to Consolidated Financial Statements

Derivative financial instruments: ALG’s subsidiaries operate globally, with manufacturing and sales facilities in various locations around the world. ALG and its subsidiaries utilize certain financial instruments to manage foreign currency exposures. Derivative financial instruments are used by ALG and its subsidiaries, principally to reduce exposures to market risks resulting from fluctuations in foreign exchange rates by creating offsetting exposures. Altria Group, Inc. is not a party to leveraged derivatives and, by policy, does not use derivative financial instruments for speculative purposes. Financial instruments qualifying for hedge accounting must maintain a specified level of effectiveness between the hedging instrument and the item being hedged, both at inception and throughout the hedged period. Altria Group, Inc. formally documents the nature and relationships between the hedging instruments and hedged items, as well as its risk-management objectives, strategies for undertaking the various hedge transactions and method of assessing hedge effectiveness. Additionally, for hedges of forecasted transactions, the significant characteristics and expected terms of the forecasted transaction must be specifically identified, and it must be probable that each forecasted transaction will occur. If it were deemed probable that the forecasted transaction will not occur, the gain or loss would be recognized in earnings currently.

Altria Group, Inc. uses forward foreign exchange contracts, foreign currency swaps and foreign currency options to mitigate its exposure to changes in exchange rates from third-party and intercompany, actual and forecasted transactions. The primary currencies to which Altria Group, Inc. is exposed include the Japanese yen, Swiss franc, euro, Turkish lira, Russian ruble and Indonesian rupiah. At December 31, 2007 and 2006, Altria Group, Inc. had contracts with aggregate notional amounts of $6.9 billion and $3.2 billion, respectively, of which $6.9 billion and $3.1 billion, respectively, were at PMI. The effective portion of unrealized gains and losses associated with qualifying contracts is deferred as a component of accumulated other comprehensive earnings (losses) until the underlying hedged transactions are reported on Altria Group, Inc.’s consolidated statement of earnings. A portion of Altria Group, Inc.’s foreign currency swaps, while effective as economic hedges, do not qualify for hedge accounting and therefore the unrealized gain (loss) relating to these contracts are reported in Altria Group, Inc.’s consolidated statements of earnings. For the years ended December 31, 2007, 2006 and 2005, the unrealized gain (loss) with regard to the contracts that do not qualify for hedge accounting was insignificant.

In addition, Altria Group, Inc. uses foreign currency swaps to mitigate its exposure to changes in exchange rates related to foreign currency denominated debt. These swaps typically convert fixed-rate foreign currency denominated debt to fixed-rate debt denominated in the functional currency of the borrowing entity, and are accounted for as cash flow hedges. At December 31, 2007 and 2006, the notional amounts of foreign currency swap agreements aggregated $1.5 billion and $1.4 billion, respectively.

Altria Group, Inc. also designates certain foreign currency denominated debt and forwards as net investment hedges of foreign operations. During the years ended December 31, 2007 and 2006, these hedges of net investments resulted in losses, net of income taxes, of $45 million and $164 million, respectively, and during the year ended December 31, 2005 resulted in a gain, net of income taxes, of $369 million. These gains and losses were reported as a component of accumulated other comprehensive earnings (losses) within currency translation adjustments.

During the years ended December 31, 2007, 2006 and 2005, ineffectiveness related to fair value hedges and cash flow hedges was not material. Altria Group, Inc. is hedging forecasted transactions for periods not exceeding the next twelve months. At December 31, 2007, Altria Group, Inc. expects an insignificant amount of gains reported in accumulated other comprehensive earnings (losses) to be reclassified to the consolidated statement of earnings within the next twelve months.

Derivative gains or losses reported in accumulated other comprehensive earnings (losses) are a result of qualifying hedging activity. Transfers of gains or losses from accumulated other comprehensive earnings (losses) to earnings are offset by the corresponding gains or losses on the underlying hedged item. Hedging activity affected accumulated other comprehensive earnings (losses), net of income taxes, during the years ended December 31, 2007, 2006 and 2005, as follows:

Notes to Consolidated Financial Statements

Note 18. Financial Instruments:

Note 18.
Financial Instruments: