Dow Chemical 2009 Annual Report Download - page 107

Table of Contents
The Dow Chemical Company and Subsidiaries
PART II, Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Dow’s business operations give rise to market risk exposure due to changes in foreign exchange rates, interest rates, commodity prices and other market
factors such as equity prices. To manage such risks effectively, the Company enters into hedging transactions, pursuant to established guidelines and
policies, which enable it to mitigate the adverse effects of financial market risk. Derivatives used for this purpose are designated as hedges per the accounting
guidance related to derivatives and hedging activities, where appropriate. A secondary objective is to add value by creating additional non-specific exposure
within established limits and policies; derivatives used for this purpose are not designated as hedges. The potential impact of creating such additional
exposures is not material to the Company’s results.
The global nature of Dow’s business requires active participation in the foreign exchange markets. As a result of investments, production facilities and
other operations on a global basis, the Company has assets, liabilities and cash flows in currencies other than the U.S. dollar. The primary objective of the
Company’s foreign exchange risk management is to optimize the U.S. dollar value of net assets and cash flows, keeping the adverse impact of currency
movements to a minimum. To achieve this objective, the Company hedges on a net exposure basis using foreign currency forward contracts, over-the-counter
option contracts, cross-currency swaps, and nonderivative instruments in foreign currencies. Exposures primarily relate to assets, liabilities and bonds
denominated in foreign currencies, as well as economic exposure, which is derived from the risk that currency fluctuations could affect the dollar value of
future cash flows related to operating activities. The largest exposures are denominated in European currencies, the Japanese yen and the Canadian dollar,
although exposures also exist in other currencies of Asia Pacific, Latin America, and India, Middle East and Africa.
The main objective of interest rate risk management is to reduce the total funding cost to the Company and to alter the interest rate exposure to the desired
risk profile. Dow uses interest rate swaps, “swaptions,” and exchange-traded instruments to accomplish this objective. The Company’s primary exposure is to
the U.S. dollar yield curve.
Dow has a portfolio of equity securities derived primarily from the investment activities of its insurance subsidiaries. This exposure is managed in a
manner consistent with the Company’s market risk policies and procedures.
Inherent in Dow’s business is exposure to price changes for several commodities. Some exposures can be hedged effectively through liquid tradable
financial instruments. Feedstocks for ethylene production and natural gas constitute the main commodity exposures. Over-the-counter and exchange traded
instruments are used to hedge these risks when feasible.
Dow uses value at risk (“VAR”), stress testing and scenario analysis for risk measurement and control purposes. VAR estimates the maximum potential
loss in fair market values, given a certain move in prices over a certain period of time, using specified confidence levels. The VAR methodology used by the
Company is a historical simulation model which captures co-movements in market rates across different instruments and market risk exposure categories.
The historical simulation model uses a 97.5 percent confidence level and the historical scenario period includes at least six months of historical data. The
2009 and 2008 year-end and average daily VAR for the aggregate of all positions are shown below. These amounts are immaterial relative to the total equity of
the Company:
Total Daily VAR at December 31 2009 2008
In millions Year-end Average Year-end Average
Foreign exchange $ 1 $ 3 $ 1 $ 3
Interest rate $ 207 $ 205 $ 161 $ 105
Equities $ 7 $ 11 $ 24 $ 16
Commodities $ 3 $ 2 $ 6 $ 13
Composite $ 212 $ 207 $ 158 $ 112
The Company’s daily VAR for the aggregate of all positions increased from a composite VAR of $158 million at December 31, 2008 to a composite of
$212 million at December 31, 2009. The increase related primarily to an increase in the interest rate VAR from $161 million to $207 million, principally due
to debt issued in the second and third quarters of 2009.
See Note J to the Consolidated Financial Statements for further disclosure regarding market risk.
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