National Grid 2008 Annual Report Download - page 591

BOWNE INTEGRATED TYPESETTING SYSTEM
CRC: 16065
Name: NATIONAL GRID
Date: 17-JUN-2008 03:10:51.35Operator: BNY99999TPhone: [phone]Site: BOWNE OF NEW YORK
Y59930.SUB, DocName: EX-15.1, Doc: 16, Page: 69
Description: EXHIBIT 15.1
0/7265.00.00.00Y59930BNY
[E/O] EDGAR 2 *Y59930/265/7*
BOWNE INTEGRATED TYPESETTING SYSTEM
CRC: 16065
Name: NATIONAL GRID
Date: 17-JUN-2008 03:10:51.35Operator: BNY99999TPhone: [phone]Site: BOWNE OF NEW YORK
Y59930.SUB, DocName: EX-15.1, Doc: 16, Page: 69 Description: EXHIBIT 15.1
0/7265.00.00.00Y59930BNY
[E/O] EDGAR 2 *Y59930/265/7*
Table of Contents
Annual Report and Accounts 2007/08
77
The performance of the Treasury function in interest rate risk
management is measured by comparing the actual total
financing costs of its debt with those of a passively-managed
benchmark portfolio.
More information on the interest rate profile of our debt is
included in note 33 to the consolidated financial statements.
Foreign exchange risk management
We have a policy of hedging certain contractually committed
foreign exchange transactions over a prescribed minimum
size. This covers a minimum of 75% of such transactions
expected to occur up to 6 months in advance and a minimum
of 50% of transactions 6 to 12 months in advance. Cover
generally takes the form of forward sale or purchase of
foreign currencies and must always relate to underlying
operational cash flows.
The principal foreign exchange risk to which we are exposed
arises from assets and liabilities denominated in US dollars.
In relation to these risks, the objective is to manage the ratio
of US dollar financial liabilities to US dollar assets, by using
debt and foreign exchange derivatives, so as to match those
liabilities to the proportion of our cash flows that arise in US
dollars and are available to service those liabilities.
In addition, we are exposed to currency exposures on
borrowings in currencies other than sterling and the US
dollar, principally the euro. This currency exposure is
managed through the use of derivative financial instruments.
The currency compositions of financial liabilities and assets
are shown in note 33 to the consolidated financial
statements.
Counterparty risk management
Counterparty risk arises from the investment of surplus funds
and from the use of derivative instruments. The Finance
Committee has agreed a policy for managing such risk,
which is controlled throu
g
h credit limits, approvals and
monitoring procedures.
Further information is provided in note 33 to the consolidated
financial statements. Where multiple transactions are
entered into with a single counterparty, a master netting
arrangement is usually put in place to reduce our exposure
to credit risk of that counterparty. At the present time, we use
standard International Swap Dealers Association
(ISDA) documentation, which provides for netting in respect
of all transactions governed by a specific ISDA agreement
with a counterparty, when transactin
g
interest rate and
exchange rate derivatives.
Derivative financial instruments held for purposes other than
trading
As part of our business operations, we are exposed to risks
arisin
g
from fluctuations in interest rates and exchan
g
e rates.
We use financial instruments, including derivatives, to
manage exposures of this type and they are a useful tool in
mana
g
in
g
risk. Our policy is not to use derivatives for tradin
g
purposes. Derivative transactions can, to varying degrees,
carry both counterparty and market risk.
We enter into interest rate swaps to mana
g
e the composition
of floating- and fixed-rate debt and so hed
g
e the exposure of
borrowings to interest rate movements. In addition, we enter
into bought and written option contracts on interest rate
swaps. These contracts are known as swaptions. We also
enter into foreign currency swaps to manage the currency
composition of borrowings and so hedge the exposure to
exchange rate movements. Certain agreements are
combined foreign currency and interest rate swap
transactions. Such agreements are known as cross-currency
swaps.
We enter into forward rate a
g
reements to hed
g
e interest rate
risk on short-term debt and money market investments.
Forward rate agreements are commitments to fix an interest
rate that is to be paid or received on a notional deposit of
specified maturity, starting at a future specified date.
Cross-currency and foreign exchange contracts are used to
manage the foreign exchange risk arising from the
investment in non-sterling subsidiaries.
More details on derivative financial instruments are provided
in note 33 to the consolidated financial statements.
Valuation and sensitivity analysis
We calculate the fair value of debt and derivative instruments
by discountin
g
all future cash flows by the market yield curve
at the balance sheet date. The market yield curve for each
currency is obtained from external sources for interest and
foreign exchange rates. In the case of instruments that
include options, the Black’s variation of the Black-Scholes
model is used to calculate fair value.