Nokia 2006 Annual Report Download - page 148

Notes to the Consolidated Financial Statements (Continued)
1. Accounting principles (Continued)
Derivatives
Fair values of forward rate agreements, interest rate options, futures contracts and exchange traded
options are calculated based on quoted market rates at each balance sheet date. Discounted cash
flow analyses are used to value interest rate and currency swaps. Changes in the fair value of these
contracts are recognized in the profit and loss account.
Fair values of cash settled equity derivatives are calculated by revaluing the contract at yearend
quoted market rates. Changes in fair value are recognized in the profit and loss account.
Forward foreign exchange contracts are valued at the market forward exchange rates. Changes in fair
value are measured by comparing these rates with the original contract forward rate. Currency
options are valued at each balance sheet date by using the Garman & Kohlhagen option valuation
model. Changes in the fair value on these instruments are recognized in the profit and loss account
except to the extent they qualify for hedge accounting.
Embedded derivatives are identified and monitored by the Group and fair valued as at each balance
sheet date. In assessing the fair value of embedded derivatives, the Group employs a variety of
methods including option pricing models and discounted cash flow analysis using assumptions that
are based on market conditions existing at each balance sheet date. The fair value changes are
recognized in the profit and loss account.
Hedge accounting
Hedging of anticipated foreign currency denominated sales and purchases
The Group applies hedge accounting for ’’Qualifying hedges’’. Qualifying hedges are those properly
documented cash flow hedges of the foreign exchange rate risk of future anticipated foreign
currency denominated sales and purchases that meet the requirements set out in IAS 39(R). The cash
flow being hedged must be ’’highly probable’’ and must present an exposure to variations in cash
flows that could ultimately affect profit or loss. The hedge must be highly effective both
prospectively and retrospectively.
The Group claims hedge accounting in respect of certain forward foreign exchange contracts and
options, or option strategies, which have zero net premium or a net premium paid, and where the
critical terms of the bought and sold options within a collar or zero premium structure are the same
and where the nominal amount of the sold option component is no greater than that of the bought
option.
For qualifying foreign exchange forwards the change in fair value that reflects the change in spot
exchange rates is deferred in shareholders’ equity to the extent that the hedge is effective. For
qualifying foreign exchange options, or option strategies, the change in intrinsic value is deferred in
shareholders’ equity to the extent that the hedge is effective. In all cases the ineffective portion is
recognized immediately in the profit and loss account. Hedging costs, either expressed as the change
in fair value that reflects the change in forward exchange rates less the change in spot exchange
rates for forward foreign exchange contracts, or changes in the time value for options, or options
strategies, are recognized within other operating income or expenses.
Accumulated fair value changes from qualifying hedges are released from shareholders’ equity into
the profit and loss account as adjustments to sales and cost of sales, in the period when the hedged
cash flow affects the profit and loss account. If the hedged cash flow is no longer expected to take
place, all deferred gains or losses are released immediately into the profit and loss account as
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