Aviva 2007 Annual Report Download - page 126
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Please find page 126 of the 2007 Aviva annual report below. You can navigate through the pages in the report by either clicking on the pages listed below, or by using the keyword search tool below to find specific information within the annual report.Interest rate and currency swaps
Interest rate swaps are contractual agreements between
two-parties to exchange periodic payments in the same
currency, each of which is computed on a different interest
rate basis, on a specified notional amount. Most interest
rate swaps involve the net exchange of payments
calculated as the difference between the fixed and floating
rate interest payments. Currency swaps, in their simplest
form, are contractual agreements that involve the exchange
of both periodic and final amounts in two different
currencies. Exposure to gain or loss on both types of swap
contracts will increase or decrease over their respective lives
as a function of maturity dates, interest and foreign
exchange rates, and the timing of payments.
Interest rate futures, forwards and options contracts
Interest rate futures are exchange-traded instruments and
represent commitments to purchase or sell a designated
security or money market instrument at a specified future
date and price. Interest rate forward agreements are OTC
where two-parties agree on an interest rate and other
terms that will become a reference point in determining,
in concert with an agreed notional principal amount, a net
payment to be made by one-party to the other, depending
what rate in fact prevails at a future point in time. Interest
rate options, which consist primarily of caps and floors,
are interest rate protection instruments that involve the
potential obligation of the seller to pay the buyer an
interest rate differential in exchange for a premium paid
by the buyer. This differential represents the difference
between current rate and an agreed rate applied to a
notional amount. Exposure to gain or loss on all interest
rate contracts will increase or decrease over their respective
lives as interest rates fluctuate.
Foreign exchange contracts
Foreign exchange contracts, which include spot, forward
and futures contracts, represent agreements to exchange
the currency of one country for the currency of another
country at an agreed price and settlement date. Foreign
exchange option contracts are similar to interest rate
option contracts, except that they are based on currencies,
rather than interest rates.
Exposure to gain or loss on these contracts will increase
or decrease over their respective lives as currency exchange
and interest rates fluctuate.
Derivative instruments for hedging
On the date a derivative contract is entered into, the
Group designates certain derivatives as either:
(i) a hedge of the fair value of a recognised asset or liability
(fair value hedge);
(ii) a hedge of a future cash flow attributable to a
recognised asset or liability, a highly probable forecast
transaction or a firm commitment (cash flow hedge); or
(iii) a hedge of a net investment in a foreign operation (net
investment hedge).
Hedge accounting is used for derivatives designated in
this way, provided certain criteria are met. At the inception
of the transaction, the Group documents the relationship
between the hedging instrument and the hedged item,
as well as the risk management objective and the strategy
for undertaking the hedge transaction. The Group also
documents its assessment of whether the hedge is
expected to be, and has been, highly effective in offsetting
the risk in the hedged item, both at inception and on an
ongoing basis.
Changes in the fair value of derivatives that are designated
and qualify as net investment or cash flow hedges, and
that prove to be highly effective in relation to the hedged
risk, are recognised in a separate reserve within equity.
Gains and losses accumulated in this reserve are included
in the income statement on disposal of the relevant
investment or occurrence of the cash flow as appropriate.
For a variety of reasons, certain derivative transactions,
while providing effective economic hedges under the
Group’s risk management positions, do not qualify for
hedge accounting under the specific IFRS rules and are
therefore treated as derivatives held for trading. Their fair
value gains and losses are recognised immediately in other
trading income.
(U) Loans
Loans with fixed maturities, including policyholder loans,
mortgage loans on investment property, securitised
mortgages and collateral loans, are recognised when cash
is advanced to borrowers. The majority of these loans are
carried at their unpaid principal balances and adjusted for
amortisation of premium or discount, non-refundable loan
fees and related direct costs. These amounts are deferred
and amortised over the life of the loan as an adjustment
to loan yield using the effective interest rate method.
Loans with indefinite future lives are carried at unpaid
principal balances or cost.
For certain mortgage loans, the Group has taken
advantage of the revised fair value option under IAS 39 to
present the mortgages, associated borrowings, other
liabilities and derivative financial instruments at fair value,
since they are managed together on a fair value basis. This
presentation provides more relevant information and
eliminates any accounting mismatch that would otherwise
arise from using different measurement bases for these
items. The fair values of mortgages classified as FV are
estimated using discounted cash flow forecasts, based on
a risk-adjusted discount rate which reflects the risks
associated with these products. They are revalued at each
period end, with movements in their fair values being
taken to the income statement.
To the extent that a loan is uncollectible, it is written-off
as impaired. Subsequent recoveries are credited to the
income statement.
(V) Collateral
The Group receives and pledges collateral in the form
of cash or non-cash assets in respect of stock lending
transactions, certain derivative contracts and loans in order
to reduce the credit risk of these transactions. The amount
and type of collateral required depends on an assessment
of the credit risk of the counterparty.
Collateral received in the form of cash, which is not legally
segregated from the Group, is recognised as an asset on
the balance sheet with a corresponding liability for the
repayment. Non-cash collateral received is not recognised
on the balance sheet unless the Group either sells or
repledges these assets in the absence of default, at which
point the obligation to return this collateral is recognised
as a liability.
Aviva plc
Annual Report and
Accounts 2007
122
Financial
statements
Accounting policies continued