Question

Excerpt from the multipage Note 7…

The Company is required to provide standby letters of creditto support certain obligations that arise in the ordinary course ofbusiness. Although the letters of credit are an off-balance sheetitem, the majority of obligations to which they relate arereflected as liabilities in the Consolidated Balance Sheet.Outstanding letters of credit totaled $211 million at December 31,2007.

The net book value of the assets pledged as collateral forthe Company’s secured borrowings, primarily aircraft and engines,was $660 million at December 31, 2007.

As of December 31, 2007, aggregate annual principalmaturities of debt and capital leases (not including amountsassociated with interest rate swap agreements and interest oncapital leases) for the five-year period ending December 31, 2012,were $40 million in 2008, $42 million in 2009, $50 million in 2010,$44 million in 2011, $418 million in 2012, and $1.5 billionthereafter.

included Excerpted from Southwest Airlines, Inc. 10-K for yearended 12/31/2007

2007 2006 inmillions

7 7/8 % Notes due2007 $- -

French Credit Agreements due2012 32 37

6 ½ % Notes due2012 386 369

5 ¼ % Notes due2014 352 336

5 ¾ % Notes due2016 300 300

5 1/8 % Notes due2017 311 300

French Credit Agreements2017 94 100

Pass ThroughCertificates 480 --

7 3/8 % Debentures due2027 103 100

Capital Leases (note8) 52 63

2110 1705

Less Currentmaturities 41 16

Less debt discount and issuancecosts 19 16

$ 2050 1567

Here is a copy of the credit report by Fitch Ratings, Ltd. atSouthwest’s $385 million, 6.5% note issuance, duein 2012:

				Ratings
Maturity Date	Currency	Total Amount	Coupon Rate	Long-term	Short-term	CUSIP	ISIN
01-MAR-2012	USD	$385,000,000	6.5%	A	--	844741AV0	US844741AV08

Here is a price quote on those same Southwest notes atthe date of issuance:

Ratings	Ticker	Description	Coupon	Maturity	YTC/YTM	Price
Baa/A	LUV	Southwest Airls Co	6.500	03-01-2012	7.450	97.29

1-4. What is the value of these notes at the 2007 balance sheetdate? Read the excerpt from

Note 10.

Prior to 2007, the Company had entered into interest rate swapagreements relating to its $385 million 6.5% senior unsecured notesdue 2012 and… Under each of these interest rate swapagreements, the Company pays the London InterBank Offered Rate(LIBOR) plus a margin every six months on the notional amount ofthe debt [what amounts to the market price of thedebt], and receives payments based on the fixedstated rate of the notes every six months until the date the notesbecome due [this is why it is called aswap]. Under the agreement related to its$385 million 6.5% senior unsecured notes due 2012, the averagefloating rate paid during 2007 is estimated to be 7.31 percentbased on actual and forward rates at December 31, 2007.

The primary objective for the Company’s use of interest ratehedges is to reduce the volatility of net interest income by bettermatching the repricing of its assets and liabilities. The Company’sinterest rate swap agreements qualify as fair value hedges, asdefined by SFAS 133. The fair values of the interest rate swapagreements, which are adjusted regularly, are recorded in theConsolidated Balance Sheet, as necessary, with a correspondingadjustment to the carrying value of the long-term debt. The fairvalue of the interest rate swap agreements, excluding accruedinterest, at December 31, 2007, was an asset of approximately $16million and is recorded in “Other deferred liabilities” in theConsolidated Balance Sheet. In accordance with fair value hedging,the offsetting entry is an adjustment to increase the carryingvalue of long-term debt. See Note 7. [we will discuss theaccounting for fair value hedges (and cash flow hedges) inInternational Accounting]

1-5. So what has happened to the general trend of interest ratesbetween the date of issuance and the end of 2007? How can you tell?What was the market rate at issuance for notes of equivalentrisk?

1-6. Why might Southwest pay off these notes back beforematurity? What effect would a repurchase at the 12/31/07 marketrate (ignoring the interest rate swap) have on Southwest’s majorfinancial statements?