"We view these hedges as more of a bet on the direction of the dollar -- and one that turned out to be wrong," Morgan Stanley analysts wrote in a recent report. "We project that these hedges have significantly cost the company in potential earnings upside."

Indeed, Baxter's hedging headache comes at a time when many U.S. companies have been the beneficiaries of the dollar's decline as their goods become cheaper abroad. The top 25 U.S. companies made 43% of their revenue abroad, with international sales up 15% from the previous year, according to Morgan Stanley, with most of these gains because of the dollar's move.

The matter also shows how the derivatives that are the tools of many hedging programs can be a mix of blessing and curse: Used wisely, these products, which derive their value from an underlying asset, can minimize volatility and protect gains. But poorly executed or used over a long period of time, they also can amplify the very losses they are designed to minimize.

Baxter's plight goes beyond the currency hedges. Baxter also entered into another type of transaction that it refers to as net-investment hedges to protect the value of its European assets, including its European facilities and inventory, according to a Baxter spokeswoman. These hedges were in the form of so-called cross-currency swaps that fix the exchange rate between dollars and euros. The spokeswoman says these swaps originally were slated to be in place until 2009, although the company is now unwinding some of these -- albeit at a cost.

By the end of the company's third quarter on Sept. 30, the total market value of the losses on what the company refers to as the "net investment hedge portfolio" amounted to $956 million, according to a presentation by Chief Financial Officer John Greisch on an Oct. 21 conference call.

Because the company has decided to "reduce the level of financial risk associated with these hedges," Mr. Greisch added on that call, Baxter was in the process of entering into offsetting hedges.

That means, he said, that half the losses, or $478 million, will be locked in. By the end of the third quarter the company had locked in about 30% of the loss, or $296 million. Baxter planned to lock in the remainder of that $478 million in the fourth quarter just ended.

The company expects the cost of entering into such offsetting hedges will amount to some $338 million in 2005 and will reduce cash flow by that amount, the spokeswoman says.

Meanwhile, the Morgan Stanley analysts calculate that the first type of hedges will have cost the company 37 cents a share over their four-year life.

The Baxter spokeswoman declined to comment on the per-share cost to the company of its hedges. In 2003, Baxter had net income of $866 million, or $1.43 a share, on sales of $8.9 billion.

An irony for Baxter is that when its hedges finally lapse, its financial performance will look better compared with the previous year.

"This ultimately reverses when the contracts expire and helps support our view that [earnings-per-share] growth in 2006 will be significant," Morgan Stanley analysts wrote in a December report.

That leaves the remainder of the cross-currency swaps. "They will be settled as they mature or possibly sooner, depending on the level of our cash flow," the Baxter spokeswoman says. "There will be additional costs."

Write to Henny Sender at henny.sender@wsj.com¹