Note 2.
Financial Instruments

Marketable Investments

The Company’s policy is to diversify its investment portfolio to reduce risk to principal that could arise from credit, geographic and investment sector risk. At May 31, 1998, investments were placed with a variety of different financial institutions or other issuers. Investments with a maturity of less than one year have a rating of A1/P1 or better. Investments with a maturity of more than one year have a minimum rating of AA/Aa2. The Company’s investment portfolio generally matures within one year or less. Gross realized gains on available-for-sale securities approximated $10.6 million, $4.1 million and $7.2 million for the years ended May 31, 1998, May 25, 1997 and May 26, 1996, respectively. Gross realized losses were not material for fiscal 1998, 1997 or 1996.

Investments at fiscal year end comprise:

(In Millions)		Gross Amortized Cost		Unrealized Gains		Estimated Fair Value
1998 Short-term Investments Available-for-sale securities: Certificates of deposit	$	23.0	$	—	$	23.0
Corporate bonds		50.4		0.1		50.5
U.S. government and federal agency debt securities		37.9		—		37.9
Foreign government bonds		1.0		—		1.0
Total short-term investments	$	112.3	$	0.1	$	112.4
1997 Short-term Investments Available-for-sale securities: Certificates of deposit	$	5.0	$	—	$	5.0
Bankers acceptances		15.0		—		15.0
Corporate bonds		7.1		—		7.1
Auction rate preferred stock		29.0		—		29.0
U.S. government and federal agency debt securities		9.0		—		9.0
Held-to-maturity securities: Auction rate preferred stock		14.5		—		14.5
Total short-term investments	$	79.6	$	—	$	79.6
Long-term Investments Available-for-sale securities: Equity securities	$	2.1	$	4.3	$	6.4
Total long-term investments	$	2.1	$	4.3	$	6.4

Gross unrealized losses were not material for either fiscal 1998 or 1997. At May 25, 1997, long-term investments of $6.4 million were included in other assets.

At May 31, 1998, the Company held $0.5 million and $429.6 million of available-for-sale and held-to-maturity securities, respectively, that are classified as cash equivalents on the consolidated balance sheet. These cash equivalents consist of the following (in millions): bank time deposits ($158.9), institutional money market funds ($9.9) and commercial paper ($261.3).

At May 25, 1997, the Company held $95.3 million and $771.7 million of available-for-sale and held-to-maturity securities, respectively, that are classified as cash equivalents on the consolidated balance sheet. These cash equivalents consist of the following (in millions): bank time deposits ($466.8), institutional money market funds ($129.2), certificates of deposit ($15.0), commercial paper ($184.8), bankers acceptances ($26.2) and demand notes ($45.0).

The net unrealized gains on available-for-sale securities of $0.1 million at May 31, 1998 and $4.3 million at May 25, 1997 are included in retained earnings.

Off-Balance Sheet Financial Instruments

Foreign Currency Instruments. The objective of the Company’s foreign exchange risk management policy is to preserve the U.S. dollar value of after-tax cash flow in relation to non-U.S. dollar currency movements. The Company uses forward and option contracts to hedge firm commitments and anticipatory exposures. These exposures primarily comprise sales of the Company’s products in currencies other than the U.S. dollar, a majority of which are made through the Company’s subsidiaries in Europe and Japan. Gains and losses on financial instruments that are intended to hedge an identifiable firm commitment are deferred and included in the measurement of the underlying transaction. Gains and losses on hedges of anticipated transactions are deferred until such time as the underlying transactions are recognized or immediately when the transaction is no longer expected to occur. In addition, the Company uses forward and option contracts to hedge certain non-U.S. dollar denominated asset and liability positions. Gains and losses on these contracts are matched with the corresponding effect of currency movements on these financial positions. Gains and losses from foreign currency transactions were not significant for fiscal 1998, 1997 and 1996.

Interest Rate Derivatives. The Company utilizes swap agreements to exchange the fixed interest rate of certain long-term U.S. dollar debt for a variable U.S. dollar interest rate and to exchange the variable interest rate of certain long-term Japanese yen debt for a fixed Japanese yen interest rate (1.7 percent at May 31, 1998). The variable rates on swaps (6.2 percent to 6.8 percent at May 31, 1998) are based primarily on U.S. dollar LIBOR and reset on a monthly, quarterly or semi-annual basis. These agreements that have maturities of up to five years involve the exchange of fixed rate interest payments for variable rate interest payments without exchange of the underlying principal amounts. The differential between fixed and variable rates to be paid or received is accrued as interest rates change in accordance with the agreements and is included in current interest expense.

The Company utilizes interest rate collars to limit the Company’s exposure to fluctuation in short-term returns on certain investments in its portfolio by locking in a range of interest rates. An interest rate collar is a no-cost structure that consists of a purchased option and a sold option, which are entered into simultaneously with the same counterparty. The Company receives a payment when the three-month LIBOR falls below predetermined levels and makes a payment when the three-month LIBOR rises above predetermined levels. These payments are recorded as adjustments to interest income. All interest rate option contracts outstanding at May 31, 1998 expire within one year.

Fair Value and Notional Principal of Off-Balance Sheet Financial Instruments. The table below shows the fair value and notional principal of the Company’s off-balance sheet instruments as of May 31, 1998 and May 25, 1997. The notional principal amounts for off-balance sheet instruments provide one measure of the transaction volume outstanding as of year-end and do not represent the amount of the Company’s exposure to credit or market loss. The estimates of fair value are based on applicable and commonly used pricing models using prevailing financial market information as of May 31, 1998 and May 25, 1997. The credit risk amount shown in the table represents the Company’s gross exposure to potential accounting loss on these transactions if all counterparties failed to perform according to the terms of the contract, based on then-current currency exchange rate or interest rate at each respective date. Although the following table reflects the notional principal, fair value and credit risk amounts of the off-balance sheet instruments, it does not reflect the gains or losses associated with the exposures and transactions that the off-balance sheet instruments are intended to hedge. The amounts ultimately realized upon settlement of these financial instruments, together with the gains and losses on the underlying exposures, will depend on actual market conditions during the remaining life of the instruments.

Transactions Qualifying for Hedge Accounting:

(In Millions)		National Principal		Estimated Fair Value		Credit Risk
1998 INTEREST RATE INSTRUMENTS Swaps: Fixed to variable	$	175.0	$	3.2	$	3.2
Variable to fixed	$	18.5	$	(0.1)	$	—
Interest rate collars	$	50.0	$	—	$	—
FOREIGN EXCHANGE INSTRUMENTS Forward contracts: To buy dollars	$	10.0	$	0.1	$	0.2
To sell dollars	$	33.3	$	(0.4)	$	0.2
Purchased options	$	28.6	$	0.8	$	0.8
1997 INTEREST RATE INSTRUMENTS Swaps: Fixed to variable	$	175.0	$	0.4	$	0.4
Variable to fixed	$	19.4	$	(0.4)	$	—
Interest rate collars	$	50.0	$	—	$	—
FOREIGN EXCHANGE INSTRUMENTS Forward contracts: To buy dollars	$	20.4	$	—	$	0.5
To sell dollars	$	45.1	$	—	$	0.2
Purchased options	$	36.5	$	0.2	$	0.2

The Company has outstanding currency exchange contracts predominantly to buy Singapore dollars and pound sterling and to sell U.S. dollars in the future. The Company also has outstanding currency exchange contracts to sell Italian lira and Japanese yen and to purchase U.S. dollars in the future. All foreign exchange forward contracts expire within one year. Unrealized gains and losses on foreign exchange forward contracts are deferred and recognized in income in the same period as the hedged transactions. Unrealized gains and losses on such agreements at May 31, 1998 and May 25, 1997 are immaterial. The Company has purchased foreign currency options denominated in Japanese yen and German deutsche mark. All foreign currency option contracts expire within one year. Premiums on purchased foreign exchange option contracts are amortized over the life of the option. Deferred gains on these option contracts are deferred until the occurrence of the hedged transaction and recognized as a component of the hedged transaction. Deferred gains on such agreements at May 31, 1998 and May 25, 1997 are immaterial.

Fair Value of Financial Instruments

A summary table of estimated fair values of financial instruments at fiscal year-end follows:

	1998				1997
(In Millions)	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Long-term investments	$	—	$	—	$	6.4	$	6.4
Long-term debt	$	(390.7)	$	(373.4)	$	(460.5)	$	(467.4)
Currency forward contracts:
To buy dollars	$	—	$	0.1	$	0.7	$	—
To sell dollars	$	0.5	$	(0.4)	$	(0.5)	$	—
Currency options	$	(0.2)	$	0.8	$	0.3	$	0.2

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to concentrations of credit risk are primarily investments and trade receivables. The Company’s investment policy requires cash investments to be placed with high-credit quality counterparties and to limit the amount of credit from any one financial institution or direct issuer. The Company sells its products to distributors and original equipment manufacturers involved in a variety of industries including computers and peripherals, automotive and telecommunications. National performs continuing credit evaluations of its customers whenever deemed necessary and generally does not require collateral. Historically, the Company has not experienced significant losses related to receivables from individual customers or groups of customers in any particular industry or geographic area.