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Financial Statements Aer Lingus Group Plc – Annual Report 2010
62
3 Financial risk management (continued)
Financial risk management is carried out by a central treasury department (group treasury) under policies approved by the board of directors.
Group treasury identifi es, evaluates and hedges fi nancial risks in close co-operation with the Group’s operating units. The board provides
written principles for overall risk management, as well as written policies covering specifi c areas, such as foreign exchange risk, interest rate
risk, credit risk, use of derivative fi nancial instruments and non-derivative fi nancial instruments, and investment of excess liquidity.
(a) Market risk
(i) Foreign exchange risk
The main currency exposures result from a defi cit in US dollars and a surplus in sterling. A large proportion of the group treasury function’s
work in relation to foreign exchange rate risk relates to the management of the Group’s cashfl ow exposures. Signifi cant currency exposures
are managed for the current and next fi nancial years on a selective hedging basis. The dollar defi cit arises because the dollar costs for fuel
and aircraft rentals, etc., exceed dollar sales in the US. The sterling surplus arises because UK sales exceed sterling costs. Profi ts are reduced
by a stronger dollar and/or a weaker sterling.
Additionally, signifi cant currency exposure results from the US dollar capital commitments relating to the purchase of aircraft. Acquisition
costs are increased by a stronger dollar.
The group treasury function manages the following currency risk generating activities: cashfl ow exposures, non-cashfl ow income statement
exposures and balance sheet exposures. The products used by the group treasury function in managing currency risk are predominantly
forward foreign exchange contracts.
Currency risks are hedged on a selective hedging basis. The Group’s risk management policy targets a minimum of 50% cover for these
exposures for the current fi nancial year and a minimum of 25% cover for the following fi nancial year.
Based on the surplus in sterling for the year ended 31 December 2010, a 5% weakening of the EUR/GBP exchange rate over the year end rate
would result in a reduction in profi t of €5.2m for the year (2009: €4.0m). Based on the defi cit in US dollars for the year ended 31 December
2010, a 5% strengthening of the EUR/USD exchange rate over the year-end rate would result in a reduction in profi t of €11.1m for the year
(2009: €15.4m).
(ii) Interest rate risk
The Group is exposed to interest rate risk associated with its long term funding requirements and its programme of surplus funds investment.
Higher interest rates increase the costs of gross debt and lower interest rates lower the returns from cash investments.
Overall the Group is in a net cash position. Interest rate exposures on debt is managed by placing matching investments, which serve as natural
hedges in relation to both interest rate and currency exposures on the debt. In addition to these investments, the Group holds surplus cash,
predominantly in euro, and therefore the major interest rate exposure the Group has is to movements in the euro interest rate. This exposure
is actively reviewed and managed. A 1% fall in interest rates based on net surplus cash throughout 2010 would reduce profi ts by €3.9m
(2009: €4.9m).
(iii) Commodity price risk
The Group’s fuel requirements expose the Group to the market volatility of jet fuel prices. The Group is subject to jet fuel price risk resulting
from its operating activities. The volatility of jet fuel prices has been signifi cant in recent years and can have a signifi cant effect on
profi tability. The primary policy objective for the management of fuel price exposure in the Group is to contribute to the achievement of the
Group’s profi tability in a risk managed and cost effective manner, reduce the volatility and increase the predictability of future fuel costs.
The group treasury function manages fuel price risk within a tightly controlled framework. From July 2009, the Group introduced a systematic
fuel hedging policy covering the following 2 year period. This systematic hedging policy targets specifi c cover levels for each following
period 24 months on a rolling basis ranging from 90% cover going into next months to 5% cover 24 months out. This generates average
cover levels of approximately 60% for the next 18 month period (rolling year 1) and 15% for the following 12 months (rolling year 2).
Notes to the consolidated fi nancial statements (continued)