BT 2003 Annual Report Download - page 123

36. Financial instruments and risk management continued
During the year ended 31 March 2002, net debt was reduced from £27.9 billion to £13.7 billion mainly by
the group’s rights issue, disposal of its Yell business, its Japanese and Spanish interests, and the property sale
and leaseback transaction. The proceeds of the rights issue and sale of assets were applied mainly in reducing
short-term borrowings. The group repaid substantially all of its medium-term notes and commercial paper in that
year. As a result of the demerger of the mmO
2
business including its European operations, the group swapped an
additional e7 billion into floating rate sterling debt. This, in conjunction with the novation of £1 billion fixed rate
swaps to Telereal for the property transaction, enabled the group to maintain its fixed:floating ratio
at approximately 88:12 at 31 March 2002.
During the year ended 31 March 2001, net debt increased from £8.7 billion to £27.9 billion mainly as a result
of the group making acquisitions of businesses and third-generation mobile licences. This increase in debt was
funded primarily by the issuance of long-term debt together with use of the group’s medium-term note
programme. As a result of this, together with the group’s interest rate swap activity, the borrowing profile
changed during that year from one mainly at floating rates to one with a fixed: floating rate ratio of
approximately 70:30. This change was in line with the group’s intention to limit the group’s exposure to interest
rate increases given the substantial size of the group’s debt portfolio at the time. During the second quarter
of the year ended 31 March 2001, it was not practical for the group to issue longer-term debt in the global capital
markets. The group therefore pre-hedged its desired fixed rate profile by transacting £9.3 billion of interest rate
swaps with maturities ranging from five to 30 years at a weighted average fixed interest payable rate of 6.2%.
The group uses financial instruments to hedge some of its currency exposures arising from its non-UK assets,
liabilities and forward purchase commitments. The group also hedges some of its interest liabilities. The financial
instruments used comprise borrowings in foreign currencies, forward foreign currency exchange contracts,
gilt locks and interest and currency swaps.
There has been no change in the nature of the group’s risk profile between 31 March 2003 and the date
of these financial statements.
The notional amounts of derivatives summarised below do not necessarily represent amounts exchanged by
the parties and, thus, are not necessarily a measure of the exposure of the group through its use of derivatives.
The amounts exchanged are calculated on the notional amounts and other terms of the derivatives which relate to
interest and exchange rates.
(a) Interest rate risk management
The group has entered into interest rate swap agreements with banks and other institutions to vary the amounts
and periods for which interest rates on borrowings are fixed. Under interest rate swaps, the group agrees with
other parties to exchange, at specified intervals, the differences between fixed rate and floating rate interest
amounts calculated by reference to an agreed notional principal amount. Under gilt locks, forward sales of UK
government long-dated treasury stock were entered into for periods of up to one year. This hedge effectively fixed
in the interest on part of the group’s then future borrowings, all of which have now been taken on.
At 31 March 2003, the group had outstanding interest rate swap agreements having a total notional principal
amount of £5,170 million (2002 – £7,870 million).
(b) Foreign exchange risk management
Cross currency swaps and forward foreign exchange contracts have been entered into to reduce the foreign
currency exposure on the group’s operations and the group’s net assets. The group also enters into forward
foreign exchange contracts to hedge investments, interest expense and purchase and sale commitments
denominated in foreign currencies (principally US dollars and the euro). The remaining terms of the currency
swaps are up to 30 years and the terms of currency forward exchange contracts are typically less than one year.
The purpose of the group’s foreign currency hedging activities is to protect the group from the risk that
the eventual net inflows and net outflows will be adversely affected by changes in exchange rates.
At 31 March 2003, the group had outstanding foreign currency swap agreements and forward exchange
contracts having a total notional principal amount of £14,545 million (2002 – £16,670 million).
The fair values of forward foreign currency contracts at 31 March 2003 were £673 million (2002 – £864
million) for purchases of currency and £1,041 million (2002 – £1,582 million) for sales of currency. These fair
values have been estimated by calculating their present values using the market discount rates, appropriate to
the terms of the contracts, in effect at the balance sheet dates.
At 31 March 2003, the group had deferred unrealised gains of £2 million (2002 – £1 million) and losses of
£nil (2002 – £13 million), based on dealer-quoted prices, from hedging purchase and sale commitments, and in
addition had deferred realised net gains of £10 million (2002 – £20 million). These are included in the profit and
loss account as part of the hedged purchase or sale transaction when it is recognised, or as gains or losses when
a hedged transaction is no longer expected to occur.
Notes to the financial statements
122 BT Annual Report and Form 20-F 2003