Nokia 2006 Annual Report Download - page 124

Market risk
Foreign exchange risk
Nokia operates globally and is thus exposed to foreign exchange risk arising from various currency
combinations. Foreign currency denominated assets and liabilities together with expected cash flows
from highly probable purchases and sales give rise to foreign exchange exposures. These transaction
exposures are managed against various local currencies because of Nokia’s substantial production
and sales outside the Eurozone.
Due to the changes in the business environment, currency combinations may also change within the
financial year. The most significant noneuro sales currencies during the year were US dollar (USD),
UK pound sterling (GBP) and Chinese yuan (CNY). In general, depreciation of another currency relative
to the euro has an adverse effect on Nokia’s sales and operating profit, while appreciation of
another currency has a positive effect, with the exception of Japanese yen (JPY), being the only
significant foreign currency in which Nokia has more purchases than sales.
The following chart shows the breakdown by currency of the underlying net foreign exchange
transaction exposure as of December 31, 2006 (in some of the currencies, especially the US dollar,
Nokia has both substantial sales as well as cost, which have been netted in the chart).
Net Exposures
GBP
6%
USD
36%
Others
16%
INR
5%
CNY
13% JPY
24%
USD
JPY
CNY
GBP
INR
Others
According to the foreign exchange policy guidelines of the Group, material transaction foreign
exchange exposures are hedged. Exposures are mainly hedged with derivative financial instruments
such as forward foreign exchange contracts and foreign exchange options. The majority of financial
instruments hedging foreign exchange risk have a duration of less than a year. The Group does not
hedge forecasted foreign currency cash flows beyond two years.
Nokia uses the ValueatRisk (‘‘VaR’’) methodology to assess the foreign exchange risk related to the
Treasury management of the Group exposures. The VaR figure represents the potential fair value
losses for a portfolio resulting from adverse changes in market factors using a specified time period
and confidence level based on historical data. To correctly take into account the nonlinear price
function of certain derivative instruments, Nokia uses Monte Carlo simulation. Volatilities and
correlations are calculated from a oneyear set of daily data. The VaR figures assume that the
forecasted cash flows materialize as expected. The annualized VaRbased FX risk figures for the Group
transaction foreign exchange exposure, including hedging transactions and Treasury exposures for
netting and risk management purposes, calculated from oneweek horizon and 95% confidence level,
are shown in Table 1, below.
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