Holiday Inn 2007 Annual Report Download - page 76

74 IHG Annual Report and Financial Statements 2007
Notes to the Group financial statements continued
Market risk exposure (continued)
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.
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 £2.9m (2006 £1.4m). A similar rise in
euro and sterling interest rates would increase the annual net
interest charge by approximately £0.6m (2006 £0.4m) and
£1.6m (2006 £1.0m) respectively.
A general weakening of the US dollar (specifically a five cent
rise in the sterling:US dollar rate) would reduce the Group’s profit
before tax by an estimated £4.2m (2006 £4.9m) and increase net
assets by an estimated £4.4m (2006 £2.6m). Similarly, a general
weakening of the euro (specifically a five cent rise in the sterling:
euro rate) would reduce the Group’s profit before tax by an
estimated £0.8m (2006 £0.9m) and decrease net assets by
an estimated £3.0m (2006 £4.0m).
Liquidity risk exposure
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 £377m 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.
At the year end, the Group had surplus cash of £52m 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 exposure
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.
The Group trades only with recognised, creditworthy third parties.
It is the Group’s policy that all customers who wish to trade on
credit terms are subject to credit verification procedures.
In respect of credit risk arising from financial assets, the Group’s
exposure to credit risk arises from default of the counterparty,
with a maximum exposure equal to the carrying amount of these
instruments.
Capital risk management
The Group manages its capital to ensure that it will be able to
continue as a going concern. The capital structure consists of net
debt, issued share capital and reserves. The structure is managed
to minimise the Group’s cost of capital, to provide ongoing returns
to shareholders and to service debt obligations, whilst
maintaining maximum operational flexibility. Surplus cash is
either reinvested in the business, used to repay debt or returned
to shareholders. The Group maintains a conservative level of debt.
The level of debt is monitored on the basis of a cash flow leverage
ratio, which is net debt divided by EBITDA. Net debt is calculated
as total borrowings less cash and cash equivalents. EBITDA is
earnings before interest, tax, depreciation and amortisation.
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 net
borrowings in major currencies. At 31 December 2007, the Group
held interest rate swaps with notional principals of USD100m,
GBP150m and EUR75m (2006 USD100m and EUR80m). 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 the fair value of cash flow hedges 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. No ineffectiveness was
recognised during the current or prior year.
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 by taking
out forward exchange contracts. The designated risk is the spot
foreign exchange risk. Forward contracts are held at fair value on
the balance sheet as other financial assets and other payables.
During the year, a £nil (2006 £3m) foreign exchange gain was
recognised in financial income, relating to gains on forward
contracts that were not classified as hedging instruments
under IAS 39.
Hedge of net investment in foreign operations
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.
Hedge effectiveness is measured at calendar quarter ends.
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. No ineffectiveness
was recognised on net investment hedges during the current or
prior year.
At 31 December 2007, the Group held foreign exchange
derivatives with a principal of £6m (2006 £220m) and a fair value
of £nil (2006 £3.5m). The maximum amount of foreign exchange
derivatives held during the year as net investment hedges and
measured at calendar quarter ends had a principal of £272m
(2006 £220m) and a fair value of £1.6m (2006 £3.5m).
21 FINANCIAL RISK MANAGEMENT POLICIES (CONTINUED)