Mercedes 2006 Annual Report Download - page 216

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Interest rate and equity price risk management.
DaimlerChrysler holds a variety of interest rate sensitive assets
and liabilities to manage the liquidity and cash needs of its
day-to-day operations. In addition a substantial volume of interest
rate sensitive assets and liabilities is related to the leasing and
sales financing business which is operated by DaimlerChrysler
Financial Services. In particular, the Group’s leasing and sales
financing business enters into transactions with customers,
primarily resulting in fixed rate receivables. DaimlerChrysler’s
general policy is to match funding in terms of maturities and
interest rates. However, for a limited portion of the receivables
portfolio, funding does not match in terms of maturities and interest
rates. As a result, DaimlerChrysler is exposed to risks due to
changes in interest rates. DaimlerChrysler coordinates funding
activities of the industrial business and financial services at the
Group level. The Group uses interest rate derivative instruments
such as interest rate swaps, forward rate agreements, swaptions,
caps and floors to achieve the desired interest rate maturities and
asset/liability structures.
The Group assesses interest rate risk by continually identifying
and monitoring changes in interest rate exposures that may
adversely impact expected future cash flows and by evaluating
hedging opportunities. The Group maintains risk management
control systems independent of Corporate Treasury to monitor
interest rate risk attributable to DaimlerChrysler’s outstanding
interest rate exposures as well as its offsetting hedge positions.
The risk management control systems involve the use of
analytical techniques, including value-at-risk analyses, to estimate
the expected impact of changes in interest rates on the Group’s
future cash flows.
Excess liquidity invested in equity securities and the corresponding
risks of derivative financial hedging instruments for equities
were not material to the Group in the reporting periods presented.
To a certain extent, the equity price risk from investments in
publicly traded companies is hedged through derivative financial
instruments.
Fair value hedges. Gains and losses from fluctuations in the fair
value of recognized assets and liabilities and firm commitments
of operating transactions as well as gains and losses arising from
derivative financial instruments designated as fair value hedges
of these recognized assets and liabilities and firm commitments
are recognized currently in revenues or cost of sales, if the
transactions being hedged involve sales (including the leasing and
sales financing business) or production of the Group’s products.
When the hedged items are recognized in financial income, net,
net gains and losses from fluctuations in the fair value of both
recognized financial assets and liabilities and derivative financial
instruments designated as fair value hedges of these financial
assets and liabilities are also recognized in financial income, net.
For the year ended December 31, 2006, net losses of €29 million
(2005: €58 million) were recognized in operating and
financial income, net, representing principally the component
of the derivative instruments’ gain or loss excluded from the
assessment of hedge effectiveness and the amount of hedging
ineffectiveness.
Cash flow hedges. Changes in the value of forward foreign
currency exchange contracts and currency options designated
and qualifying as cash flow hedges are reported in accumulated
other comprehensive income/(loss). These amounts are
subsequently reclassified into operating income in the same
period the underlying transactions affect operating income.
Changes in the fair value of derivative hedging instruments desig-
nated as hedges of variability of cash flows associated with
variable-rate long-term debt are also reported in accumulated other
comprehensive income/(loss). These amounts are subsequently
reclassified into the income statement as a yield adjustment in the
same period in which the related interest on the floating-rate
debt obligations affect earnings. If the interest sensitive hedged
items affect operating income (including the leasing and sales
financing business), the effects from the hedging instruments are
also recognized in operating income. If the interest sensitive
hedged items affect financial income, net, the corresponding
effects from the hedging instruments are likewise classified
in financial income, net.
For the year ended December 31, 2006, gains of €1 million
(2005: losses of €41million), representing principally the
component of the derivative instruments’ gain/loss excluded
from the assessment of the hedge effectiveness and the
amount of hedging ineffectiveness, were recognized in operating
and financial income, net.
During 2006, DaimlerChrysler recorded no income or
expenses as a result of the discontinuance of cash flow
hedges (2005: expenses of €1 million).
It is anticipated that €346 million of net gains included in
accumulated other comprehensive income/(loss) at December 31,
2006, will be reclassified into earnings during the next year.
As of December 31, 2006, DaimlerChrysler held derivative
financial instruments with a maximum maturity of 29 months
to hedge its exposure to the variability in future cash flows
from foreign currency forecasted transactions.
Hedges of the net investment in a foreign operation.
In specific circumstances, DaimlerChrysler hedges the currency
risk inherent in certain of its long-term investments where
the functional currency is other than the euro, through the use of
derivative and non-derivative financial instruments. For the year
ended December 31, 2005, net gains of €213 million (2004: €120
million) from hedging the Group’s net investment in Mitsubishi
Motors Corporation were reclassified into the income statement.
For further information, also the discussion in Note 3. As of
December 31, 2006, net losses of €9 million from hedging the
Group’s net investments in foreign operations were included
in the cumulative transition adjustment without affecting Daimler-
Chrysler’s net income in prior years.