Toyota 2005 Annual Report Download - page 77

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS >75
Foreign Currency Exchange Rate Risk
Toyota has foreign currency exposures related to buying,
selling and financing in currencies other than the local
currencies in which it operates. Toyota is exposed to
foreign currency risk related to future earnings or assets
and liabilities that are exposed due to operating cash flows
and various financial instruments that are denominated in
foreign currencies. Toyota’s most significant foreign cur-
rency exposures relate to the United States and Western
European countries.
Toyota uses a value-at-risk analysis (“VAR”) to evaluate
its exposure to changes in foreign currency exchange rates.
The value-at-risk of the combined foreign exchange position
represents a potential loss in pre-tax earnings that are
estimated to be ¥37.8 billion as of March 31, 2004 and ¥57.1
billion as of March 31, 2005. Based on Toyota’s overall
currency exposure (including derivative positions), the risk
during the year ended March 31, 2005 to pre-tax cash flow
from currency movements was on average ¥50.6 billion,
with a high of ¥57.1 billion and a low of ¥46.6 billion.
The VAR was estimated by using a Monte Carlo
Simulation method and assumed 95% confidence level on
the realization date and a 10-day holding period.
Interest Rate Risk
Toyota is subject to market risk from exposures to changes
in interest rates based on its financing, investing and cash
management activities. Toyota enters into various
financial instrument transactions to maintain the desired
level of exposure to the risk of interest rate fluctuations
and to minimize interest expense. Certain exchange traded
future and option contracts, interest rate caps and floors,
along with various investments, have been entered into to
reduce the interest rate risk related to these activities. The
potential decrease in fair value resulting from a hypothe-
tical 100 basis point upward shift in interest rates would
be approximately ¥29.6 billion as of March 31, 2004 and
¥56.3 billion as of March 31, 2005.
There are certain shortcomings inherent to the sensitivity
analyses presented. The model assumes interest rate
changes are instantaneous parallel shifts in the yield curve;
however, in reality, changes are rarely instantaneous.
Although certain assets and liabilities may have similar
maturities or periods to repricing, they may not react
correspondingly to changes in market interest rates. Also,
the interest rates on certain types of assets and liabilities
may fluctuate with changes in market interest rates, while
interest rates on other types of assets may lag behind
changes in market rates. Finance receivables are less
susceptible to prepayments when interest rates change
and, as a result, Toyota’s model does not address prepay-
ment risk for automotive related finance receivables.
However, in the event of a change in interest rates, actual
loan prepayments may deviate significantly from the
assumptions used in the model.
Commodity Price Risk
Commodity price risk is the possibility of higher or lower
costs due to changes in the prices of commodities, such as
non-ferrous (e.g., aluminum), precious metals (e.g.,
palladium, platinum and rhodium) and ferrous alloys
(e.g., steel), which Toyota uses in the production of motor
vehicles. Toyota does not use derivative instruments to
hedge the price risk associated with the purchase of those
commodities and controls its commodity price risk by
holding minimum stock levels.
Equity Price Risk
Toyota holds investments in various available-for-sale
equity securities which are subject to price risk. The fair
value of available-for-sale equity securities was ¥952.5
billion as of March 31, 2004 and ¥904.8 billion as of
March 31, 2005. The potential change in the fair value of
these investments, assuming a 10% change in prices,
would be approximately ¥95.2 billion as of March 31, 2004
and ¥90.4 billion as of March 31, 2005.