Holiday Inn 2006 Annual Report Download - page 72

Notes to the Group financial statements
21 Financial risk management policies
Financial instruments
The Group’s treasury policy is to manage financial risks that arise
in relation to underlying business needs. The activities of the
treasury function are carried out in accordance with Board
approved policies and are subject to regular audit. The treasury
function does not operate as a profit centre.
The treasury function seeks to reduce the financial risk of the
Group and manages liquidity to meet all foreseeable cash needs.
Treasury activities include money market investments, spot and
forward foreign exchange instruments, currency options, currency
swaps, interest rate swaps and options and forward rate
agreements. One of the primary objectives of the Group’s treasury
risk management policy is to mitigate the adverse impact of
movements in interest rates and foreign exchange rates.
The US dollar is the predominant currency of the Group’s revenue
and cash flows and movements in foreign exchange rates,
particularly the US dollar and euro, can affect the Group’s reported
profit, net assets and interest cover. To hedge this translation
exposure the Group matches the currency of its debt (either
directly or via derivatives) to the currency of its net assets, whilst
maximising the amount of US dollars borrowed.
Foreign exchange transaction exposure is managed by the forward
purchase or sale of foreign currencies or the use of currency
options. Most significant exposures of the Group are in currencies
that are freely convertible.
Interest rate exposure is managed within parameters that stipulate
that fixed rate borrowings should normally account for no less than
25% and no more than 75% of net borrowings for each major
currency. This is achieved through the use of interest rate swaps
and options and forward rate agreements.
The treasury function ensures that the Group has access to
sufficient funds to allow the implementation of the strategy set
by the Board. At the year end, the Group had access to £944m of
undrawn committed facilities. Medium and long-term borrowing
requirements are met through the £1.1bn Syndicated Facility and
short-term borrowing requirements are met from drawings under
bilateral bank facilities. The Group is in compliance with all of the
financial covenants in its loan documents, none of which is
expected to present a material restriction on funding or investment
policy in the near future. In addition, the Group had surplus cash
of £179m which is held in short-term deposits and cash funds
which allow daily withdrawals of cash. Most of the Group’s surplus
funds are held in the UK or US and there are no material funds
where repatriation is restricted as a result of foreign exchange
regulations. Credit risk on treasury transactions is minimised by
operating a policy on the investment of surplus cash that generally
restricts counterparties to those with an A credit rating or better
or those providing adequate security.
Sensitivities
Based on the year end net debt position and given the underlying
maturity profile of investments, borrowings and hedging
instruments at that date, a one percentage point rise in US dollar
interest rates would increase the annual net interest charge by
approximately £1m (2005 £1m).
A general weakening of the US dollar (specifically a one cent rise
in the sterling:US dollar rate) would have reduced the Group’s profit
before tax by an estimated £1m (2005 £1m).
Hedging
Interest rate risk The Group hedges its interest rate risk by taking
out interest rate swaps to fix the interest flows on between 25%
and 75% of its borrowings in major currencies. At 31 December
2006, the Group held interest rate swaps with notional principals
of USD100m and EUR80m (2005 USD200m and EUR160m). The
interest rate swaps are designated as cash flow hedges of
borrowings under the syndicated loan facility and they are held
on the balance sheet at fair value in other financial assets and
other payables.
Changes in cash flow hedge fair values are recognised in the
unrealised gains and losses reserve to the extent that the hedges
are effective. When the hedged item is recognised, the cumulative
gains and losses on the hedging instrument are recycled to the
income statement.
Foreign currency risk The Group is exposed to foreign currency
risk on income streams denominated in foreign currencies. When
appropriate, the Group hedges a portion of forecast foreign
currency income and asset disposal proceeds by taking out forward
exchange contracts. When hedge accounting is applied, the spot
foreign exchange rate is designated as the hedged risk and so the
Group takes the forward points on these contracts through financial
income or expense.
Forward contracts are held at fair value on the balance sheet as
other financial assets and other payables.
During the year, a £3m (2005 £nil) foreign exchange gain was
recognised in finance income, relating to gains on forward contracts
that were not classified as hedging instruments under IAS 39.
During the prior year, gains of £6m were recycled to the income
statement from the unrealised gains and losses reserve in respect
of effective hedges.
Hedge of net investment in a foreign operation The Group
designates its foreign currency bank borrowings and currency
derivatives as net investment hedges of foreign operations. The
designated risk is the spot foreign exchange risk; the interest on
these financial instruments is taken through financial income or
expense and the derivatives are held on the balance sheet at fair
value in other financial assets and other payables. Variations in fair
value due to changes in the underlying exchange rates are taken to
the currency translation reserve until an operation is sold, at which
point the cumulative currency gains and losses are recycled against
the gain or loss on sale.
70 IHG Annual report and financial statements 2006