BT 2007 Annual Report Download - page 128

33. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT continued
The group does not hold or issue derivative financial instruments for trading purposes. All transactions in derivative financial
instruments are undertaken to manage the risks arising from underlying business activities.
The group’s profile of borrowings and short-term funds is managed with consideration of the cash flow from operations. These
borrowings and short term funds are managed by the centralised treasury operation. The types of financial instrument used for
investment of short term funds are prescribed in group treasury policies with limits on the exposure to any one organisation.
Short term investment in financial instruments is partially undertaken on behalf of the group by substantial external fund managers
who are limited to dealing in debt instruments and certain defined derivative instruments and are given strict guidelines on credit,
diversification and maturity profiles.
The group has a centralised treasury operation whose primary role is to manage liquidity, funding, investment and the group’s
financial risk, including risk from volatility in currency and interest rates and counterparty credit risk. The treasury operation is not a
profit centre and the objective is to manage risk at optimum cost.
The Board sets the policy for the group’s centralised treasury operation and its activities are subject to a set of controls
commensurate with the magnitude of the borrowings and investments under its management. Counterparty credit risk is closely
monitored and managed within controls set by the Board.
During the year ended 31 March 2007, the group’s net debt (note 10) increased from £7.5 billion to £7.9 billion mainly due to
outflows arising on investing activities such as capital expenditure and acquisitions, and from financing activities such as dividend
and net interest payments which more than offset inflows mainly arising from operating activities. During the 2007 financial year,
debt amounting to £1.1 billion matured consisting of the 2006 sterling 7.375% notes, finance leases and other sterling floating rate
loans and notes. This was offset by increased holdings of commercial paper and lower current financial assets and cash and cash
equivalent investments.
During the year ended 31 March 2006 the group’s net debt (note 10) reduced from £7.9 billion to £7.5 billion mainly due to
operational and working capital inflows. During the 2006 financial year two substantial notes matured, namely the 2005 US dollar
7.875% notes and 2006 Euro 6.375% notes amounting to £3.8 billion and were primarily funded from current financial assets and
cash and cash equivalents. The group utilised its commercial paper programme during the year, which was supported by a
committed borrowing facility, as well as raising a sterling floating rate borrowing of £1 billion.
There has been no change in the nature of the group’s risk profile between 31 March 2007 and the date of these financial
statements.
Interest rate risk management
The group has interest bearing financial assets and financial liabilities. The group’s policy is to ensure that at least 70% of net debt is
at fixed rates. In order to manage this profile, the group has entered into interest rate swap agreements with commercial 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.
The majority of the group’s long-term borrowings have been, and are, subject to fixed sterling interest rates after applying the
impact of hedging instruments. At 31 March 2007, the group had outstanding interest rate swap agreements with notional principal
amounts totalling £5.1 billion (2006: £5.1 billion).
At 31 March 2007, the group’s fixed:floating interest rate profile, after hedging, on net debt was 75:25 (2006: 85:15).
Based on the composition of net debt at 31 March 2007, a one percentage point increase in interest rates would increase the
group’s annual net finance expense by approximately £11 million (2006: £10 million).
Foreign exchange risk management
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.
Most of the group’s current revenue is invoiced in pounds sterling, and most of its operations and costs arise within the UK. The
group’s foreign currency borrowings which totalled £5.3 billion at 31 March 2007 (2006: £5.4 billion), are used to finance its
operations. These borrowings have been predominantly swapped to sterling. Cross currency swaps and forward currency 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 currency contracts to hedge foreign currency investments, interest expense, capital purchases and purchase
and sale commitments on a selective basis. The commitments hedged are principally US dollar and euro denominated. As a result of
these policies, the group’s exposure to foreign currency arises mainly on the residual currency exposure on its non-UK investments in
its subsidiaries and on imbalances between the value of outgoing and incoming international calls.
A 10% strengthening in sterling against major currencies would cause the group’s net assets at 31 March 2007 to fall by less
than £220 million (2006: £150 million), with an insignificant effect on the group’s profits.
At 31 March 2007, the group had outstanding contracts to sell or purchase foreign currency with a total gross notional principal
of £6.1 billion (2006: £6.4 billion). The majority of these instruments were cross currency swaps with a remaining term ranging from
2 months to 24 years. The notional value of forward currency contracts included in the gross notional principal at 31 March 2007
were £1,297 million (2006: £809 million) for purchases of currency and £2 million (2006: £781 million) for sales of currency. The
forward currency contracts had a term remaining ranging from 2 to 321 days.
BT Group plc Annual Report & Form 20-F 127
Financial statements