Notes to Consolidated Financial Statements

(Continued)

Note 18.
Financial Instruments:

Derivative financial instruments: Altria Group, Inc. operates globally, with manufacturing and sales facilities in various locations around the world, and utilizes certain financial instruments to manage its foreign currency and commodity exposures. Derivative financial instruments are used by Altria Group, Inc., principally to reduce exposures to market risks resulting from fluctuations in foreign exchange rates and commodity prices, 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 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 and the euro. At December 31, 2004 and 2003, Altria Group, Inc. had foreign exchange option and forward contracts with aggregate notional amounts of $9.7 billion and $13.6 billion, respectively. The $3.9 billion decrease from December 31, 2003, reflects $3.0 billion due to the maturity of a substantial portion of equal and offsetting foreign currency transactions discussed below, as well as the maturity of contracts that were outstanding at December 31, 2003, partially offset by new agreements in 2004. Included in the foreign currency aggregate notional amounts at December 31, 2004 and 2003, were $0.4 billion and $3.4 billion, respectively, of equal and offsetting foreign currency positions, which do not qualify as hedges and that will not result in any significant gain or loss. The effective portion of unrealized gains and losses associated with forward contracts and option 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.

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. A substantial portion of the foreign currency swap agreements is accounted for as cash flow hedges. The unrealized gain (loss) relating to foreign currency swap agreements that do not qualify for hedge accounting treatment under U.S. GAAP was insignificant as of December 31, 2004 and 2003. At December 31, 2004 and 2003, the notional amounts of foreign currency swap agreements aggregated $2.7 billion and $2.5 billion, respectively. Aggregate maturities of foreign currency swap agreements at December 31, 2004, were as follows:

(in millions)
2006		$1,203
2008		1,449
		$ 2,652

Altria Group, Inc. also designates certain foreign currency denominated debt as net investment hedges of foreign operations. During the years ended December 31, 2004, 2003 and 2002, losses, net of income taxes, of $344 million, $286 million and $366 million, respectively, which represented effective hedges of net investments, were reported as a component of accumulated other comprehensive earnings (losses) within currency translation adjustments.

Kraft is exposed to price risk related to forecasted purchases of certain commodities used as raw materials. Accordingly, Kraft uses commodity forward contracts as cash flow hedges, primarily for coffee, cocoa, milk and cheese. Commodity futures and options are also used to hedge the price of certain commodities, including milk, coffee, cocoa, wheat, corn, sugar and soybean oil. At December 31, 2004 and 2003, Kraft had net long commodity positions of $443 million and $255 million, respectively. In general, commodity forward contracts qualify for the normal purchase exception under U.S. GAAP. The effective portion of unrealized gains and losses on commodity futures and option contracts is deferred as a component of accumulated other comprehensive earnings (losses) and is recognized as a component of cost of sales when the related inventory is sold. Unrealized gains or losses on net commodity positions were immaterial at December 31, 2004 and 2003.

During the years ended December 31, 2004, 2003 and 2002, 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 fifteen months. At December 31, 2004, Altria Group, Inc. estimates that derivative losses of $36 million, net of income taxes, reported in accumulated other comprehensive earnings (losses) will 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, 2004, 2003 and 2002, as follows:

(in millions) 2004      2003 2002 (Loss) gain as of January 1 $(83)     $(77 ) $   33   Derivative losses (gains)     transferred to earnings 86      (42 ) 1   Change in fair value (17)     36 (111 ) Loss as of December 31 $(14)     $(83 ) $  (77 ) Credit exposure and credit risk: Altria Group, Inc. is exposed to credit loss in the event of nonperformance by counterparties. Altria Group, Inc. does not anticipate nonperformance within its consumer products businesses. However, see Note 8. Finance Assets, net regarding certain aircraft leases. Fair value: The aggregate fair value, based on market quotes, of Altria Group, Inc.’s total debt at December 31, 2004, was $24.2 billion, as compared with its carrying value of $23.0 billion. The aggregate fair value of Altria Group, Inc.’s total debt at December 31, 2003, was $25.8 billion, as compared with its carrying value of $24.5 billion. The fair value, based on market quotes, of Altria Group, Inc.’s equity investment in SABMiller at December 31, 2004, was $7.1 billion, as compared with its carrying value of $2.5 billion. The fair value of Altria Group, Inc.’s equity investment in SABMiller at December 31, 2003, was $4.4 billion, as compared with its carrying value of $2.1 billion. See Notes 9 and 10 for additional disclosures of fair value for short-term borrowings and long-term debt.