Siemens 2006 Annual Report Download - page 147

Management’s discussion and analysis 143
Effects of currency translation
Many of our subsidiaries are located outside the euro zone. Since our financial reporting cur-
rency is the euro, we translate the financial statements of these subsidiaries into euros so that
we can include their financial results in our Consolidated Financial Statements. To consider
the effects of foreign exchange translation risk in our risk management, our working assump-
tion is that investments in our foreign-based operations are permanent and that reinvestment
is continual. Whenever a divestment of a particular asset or entity is made, we incorporate the
value of this transaction risk in our sensitivity analyses. Effects from currency fluctuations on
the translation of net asset amounts into euro are reflected in the Siemens consolidated equity
position.
Interest rate exposure
Our interest rate risk exposure is mainly related to debt obligations like bonds, loans, com-
mercial paper programs and interest bearing deposits and investments. We measure interest
rate risk by using either fair value sensitivity or cash flow sensitivity depending on whether
the instrument has a fixed or variable interest rate. We generate total fair value sensitivity as
well as the total cash flow sensitivity by aggregating the sensitivities of the various exposures
denominated in different currencies. Depending on whether we have a long or short interest
position, interest rate risk can arise on increasing or decreasing market moves in the relevant
yield curve.
The fair value sensitivity calculation for fixed interest instruments shows the change in fair
value, defined as present value, caused by a hypothetical 100-basis point shift in the yield
curve. The first step in this calculation is to use the yield curve to discount the gross cash flows,
meaning the present value of future interest and principal payments of financial instruments
with fixed interest rates. A second calculation discounts the gross cash flows using a 100-basis
point shift of the yield curve. In all cases, we use the generally accepted and published yield
curves on the relevant balance sheet date. The fair value interest rate risk results primarily
from long-term fixed rate debt obligations and interest bearing investments. Assuming a 100-
basis point decrease in interest rates, this risk was €24 million at September 30, 2006, decreas-
ing from the comparable value of €34 million at September 30, 2005 assuming a 100-basis
point decrease in interest rates. We seek to limit this risk through the use of derivative instru-
ments which allow us to hedge fair value changes by swapping fixed rates of interest into vari-
able rates of interest.
For variable rate instruments, the interest rate risk is monitored by using the cash flow sen-
sitivity also assuming a 100-basis point shift of the yield curves. Such risk mainly results from
hedges of fixed rate debt obligations that swap fixed rates of interest into variable rates of
interest. This exposure leads to a cash flow interest rate risk of €32 million at September 30,
2006, compared to €2 million the year before, assuming a 100-basis point increase in interest
rates.
To optimize the group’s position with regard to interest income and interest expenses and
to minimize the overall financial interest rate risk, Corporate Treasury performs corporate
interest rate risk management together with SFS as operating service provider. Part of the
interest rate risk management concept is a Corporate-wide interest overlay management to
match interest periods of our hedges with intended maturities of assets and liabilities. Where
it is not contrary to country-specific regulations, all Groups and affiliated companies generally
obtain any required financing through Corporate Treasury in the form of loans or intercom-
pany clearing accounts. The same concept is adopted for deposits of cash generated by the
units.
We also mitigate interest rate risk by entering into interest rate derivative instruments.
For additional information see “Notes to Consolidated Financial Statements.”
Management’s discussion and analysis