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33. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT continued
The majority of the group’s long-term borrowings have been, and are, subject to fixed sterling interest rates after applying the
impact of hedging instruments. At 31 March 2006, the group had outstanding interest rate swap agreements with notional
principal amounts totalling £5.1 billion compared to £5.3 billion at 31 March 2005.
At 31 March 2006, the group’s fixed:floating interest rate profile, after hedging, on net debt was 86:14 (2005: 95:5).
Based on the composition of net debt at 31 March 2006, a one percentage point increase in interest rates would increase the
group’s annual net finance expense by approximately £10 million. This is consistent with the position at 31 March 2005.
Foreign exchange risk management
The purpose of the group’s foreign currency hedging activities is to protect the group from the risk that the eventual net inflows
and net outflows will be adversely affected by changes in exchange rates.
Most of the group’s current revenue is invoiced in pounds sterling, and most of its operations and costs arise within the UK. The
group’s foreign currency borrowings which totalled £5.4 billion at 31 March 2006, are used to finance its operations. The
borrowings have been predominantly swapped to sterling. Cross currency swaps and forward currency contracts have been entered
into to reduce the foreign currency exposure on the group’s operations and the group’s net assets. The group also enters into
forward currency contracts to hedge foreign currency investments, interest expense, capital purchases and purchase and sale
commitments on a selective basis. The commitments hedged are principally US dollar and euro denominated. As a result of these
policies, the group’s exposure to foreign currency arises mainly on the residual currency exposure on its non-UK investments in its
subsidiaries and on imbalances between the value of outgoing and incoming international calls.
A 10% strengthening in sterling against major currencies would cause the group’s net assets at 31 March 2006 to fall by less
than £150 million, with an insignificant effect on the group’s profits. This is consistent with the position at 31 March 2005.
At 31 March 2006, the group had outstanding contracts to sell or purchase foreign currency with a total gross notional principal
of £6.4 billion (2005: £9.8 billion). The majority of these instruments were cross currency swaps with a remaining term ranging
from 1 to 25 years. The values of forward currency contracts included in the gross notional principal at 31 March 2006 were
£809 million (2005: £427 million) for purchases of currency and £781 million (2005: £782 million) for sales of currency. The
forward currency contracts had a term remaining ranging from three to 364 days.
Credit risk management
The group considers that it is not exposed to major concentrations of credit risk. The group, however, is exposed to credit-related
losses in the event of non-performance by counterparties to financial instruments, but does not expect any counterparties to fail to
meet their obligations. The group limits the amount of credit exposure to any one counterparty. Where multiple transactions are
undertaken with a single counterparty, or group of related counterparties, the group may enter into a netting arrangement to
reduce the group’s exposure to credit risk. Currently the group makes use of standard International Swaps and Derivative
Association (ISDA) documentation. In addition, where management have a legal right of set off and the ability and intention to
settle net, the relevant asset and liabilities are netted within the balance sheet. The group seeks collateral or other security where it
is considered necessary.
The maximum credit risk exposure of the group’s financial assets at 31 March 2006 is represented by the amounts reported
under the corresponding balance sheet headings.
Liquidity risk management
The group ensures its liquidity is maintained by entering into long and short term financial instruments to support operational and
other funding requirements. The group’s liquidity and funding management process includes projecting cash flows and considering
the level of liquid assets in relation thereto, monitoring balance sheet liquidity and maintaining a diverse range of funding sources
and back-up facilities. Liquid assets surplus to immediate operating requirements of the group are generally invested and managed
by the centralised treasury function. Requirements of group companies for operating finance are met whenever possible from
central resources.The group manages liquidity risk by maintaining adequate committed borrowing facilities. During the year the
group utilised its commercial paper programme which was supported by a committed borrowing facility of up to £1,535 million
(2005: £145 million). Of this total, £1,500 million of the borrowing facility is available for a period of five years. Refinancing risk is
managed by limiting the amount of borrowing that matures within any specified period.
Price risk management
The group has limited exposure to equity securities price risk on investments held by the group.
Hedging activities
The group entered into a combination of interest rate and cross currency swaps designated as a combination of fair value and cash
flow hedges in order to hedge certain risks associated with the the group’s US dollar and euro borrowings. The risks being hedged
consist of currency cash flows associated with future interest and principal payments and the fair value risk of certain elements of
borrowings arising from fluctuations in currency rates and interest rates.
At 31 March 2006, the group had outstanding interest rate swap agreements in cash flow hedges against borrowings with a
total notional principal amount of £3.2 billion. The fair value of these interest rate swaps at the balance sheet date comprised
liabilities of £405 million. The interest rate swaps have a remaining term ranging from four to 25 years to match the underlying
hedged cash flows arising on the borrowings consisting of annual and semi-annual interest payments. The interest receivable under
these swap contracts are at a weighted average rate of 4.6% and interest payable are at a weighted average rate of 5.9%.
BT Group plc Annual Report and Form 20-F 2006 Notes to the consolidated financial statements106