30. Financial instruments

The relationship between classes and categories as well as the reconciliation to the statement of financial position line items is shown in the following table:

The derivative financial instruments embedded in the MEB are included in the statement of financial position item long-term accrued expenses and other long-term liabilities (in 2008: other non-current assets) (for details relating to the MEB, please see note 23, Mandatory Exchangeable Bonds). Due to their special character and the difference in valuation, the embedded derivatives are classified separately. Also because of their special character and different valuation, the CVR are classified separately from their statement of financial position item.

Valuation of financial instruments

The carrying amounts of financial instruments at December 31, classified into categories, were as follows:

in million € 2009 2008
1 There are no financial instruments designated as at fair value through profit or loss upon initial recognition.
Loans and receivables 2,535 2,499
Financial liabilities measured at amortized cost 9,416 9,903
Assets measured at fair value 1 11 48
Liabilities measured at fair value 1 73 61
Relating to no category 267 148

in million € 2009 2008
1 There are no financial instruments designated as at fair value through profit or loss upon initial recognition.
Loans and receivables 2,535 2,499
Financial liabilities measured at amortized cost 9,416 9,903
Assets measured at fair value 1 11 48
Liabilities measured at fair value 1 73 61
Relating to no category 267 148

Estimation of fair values of financial instruments

The significant methods and assumptions used to estimate the fair values of financial instruments are as follows:

Cash and cash equivalents are stated at nominal value which equals the fair value.

The nominal value of short-term financial instruments like accounts receivables and payables and short-term debt represents its carrying amounts, which is a reasonable estimate of the fair value due to the relatively short period to maturity of these instruments.

The fair values of the major long-term financial instruments are calculated on the basis of market information. Financial instruments for which market quotes are available are measured with the market quotes at the reporting date. The fair values of the other long-term financial liabilities are calculated at present value of respective future cash flows. To determine these present values, the prevailing interest rates and credit spreads for the Fresenius Group as of the date of the statement of financial position are used.

The carrying amounts of derivatives embedded in the MEB and the CVR correspond with their fair values. The embedded derivatives have to be measured at fair value, which is estimated based on a Black-Scholes model. The CVR are traded at the stock exchange in the United States and are therefore valued with the current stock exchange price at the reporting date.

Derivatives, mainly consisting of interest rate swaps and foreign exchange forward contracts, are valued as follows: The fair value of interest rate swaps is calculated by discounting the future cash flows on the basis of the market interest rates applicable for the remaining term of the contract as of the date of the statement of financial position. To determine the fair value of foreign exchange forward contracts, the contracted forward rate is compared to the current forward rate for the remaining term of the contract as of the date of the statement of financial position. The result is then discounted on the basis of the market interest rates prevailing at the date of the statement of financial position for the respective currency.

Fresenius Group’s own credit risk is incorporated in the fair value estimation of derivatives that are liabilities. Counterparty credit-risk adjustments are factored into the valuation of derivatives that are assets.

Fair value of financial instruments

The following table presents the carrying amounts and fair values of the Group’s financial instruments as of December 31:

  2009 2008
in million € Carrying amount Fair value Carrying amount Fair value
Cash and cash equivalents 420 420 370 370
Assets recognized at carrying amount 2,535 2,535 2,499 2,499
Assets recognized at fair value 0 0 8 8
Liabilities recognized at carrying amount 9,461 9,611 9,945 9,835
Liabilities recognized at fair value 55 55 41 41
Derivatives designated as hedging instruments - 115 - 115 - 160 - 160

  2009 2008
in million € Carrying amount Fair value Carrying amount Fair value
Cash and cash equivalents 420 420 370 370
Assets recognized at carrying amount 2,535 2,535 2,499 2,499
Assets recognized at fair value 0 0 8 8
Liabilities recognized at carrying amount 9,461 9,611 9,945 9,835
Liabilities recognized at fair value 55 55 41 41
Derivatives designated as hedging instruments - 115 - 115 - 160 - 160

Derivatives for hedging purposes as well as derivatives embedded in the MEB were recognized at gross values as other assets in an amount of € 49 million and other liabilities in an amount of € 185 million.

Derivative and non-derivative financial instruments recognized at fair value are classified according to the three-tier fair value hierarchy. For the fair value measurement of derivatives for hedging purposes, significant other observable inputs are used. Therefore, they are classified as Level 2 in accordance with the defined fair value hierarchy levels. The derivatives embedded in the MEB are also classified as Level 2. The valuation of the CVR is based on the current stock exchange price, they are therefore classified as Level 1. The liabilities recognized at fair value consist of embedded derivatives and the CVR and are consequently classified in their entirety as the lower hierarchy Level 2. Financial instruments that would have to be classified as Level 3 do not exist within the Fresenius Group.

Fair values of derivative financial instruments


  December 31, 2009
in million € Assets Liabilities
1Derivatives designated as hedging instruments and foreign exchange contracts not designated as hedging instruments are classified as derivatives for hedging purposes.
Interest rate contracts (current)
Interest rate contracts (non-current) 134
Foreign exchange contracts (current) 18 11
Foreign exchange contracts (non-current) 20 1
Derivatives designated as hedging instruments 1 38 146
     
Foreign exchange contracts (current) 1 11 17
Foreign exchange contracts (non-current) 1 1
Derivatives embedded in the MEB (non-current) 0 21
Derivatives not designated as hedging instruments 11 39

  December 31, 2009
in million € Assets Liabilities
1Derivatives designated as hedging instruments and foreign exchange contracts not designated as hedging instruments are classified as derivatives for hedging purposes.
Interest rate contracts (current)
Interest rate contracts (non-current) 134
Foreign exchange contracts (current) 18 11
Foreign exchange contracts (non-current) 20 1
Derivatives designated as hedging instruments 1 38 146
     
Foreign exchange contracts (current) 1 11 17
Foreign exchange contracts (non-current) 1 1
Derivatives embedded in the MEB (non-current) 0 21
Derivatives not designated as hedging instruments 11 39

Derivative financial instruments are marked to market each reporting period resulting in carrying amounts being equal to fair values at reporting date.

Derivatives not designated as hedging instruments, which are derivatives that do not qualify for hedge accounting, are also solely used to hedge economic business transactions and not for speculative purposes.

The current portions of interest rate contracts and foreign exchange contracts indicated as assets in the table on the previous page are recognized as other current assets in the statement of financial position while the current portions of those indicated as liabilities are included in short-term accrued expenses and other short-term liabilities. The non-current portions indicated as assets or liabilities are recognized as other non-current assets or as long-term accrued expenses and other long-term liabilities, respectively. The derivatives embedded in the MEB are recognized as other non-current assets / other long-term liabilities.

Effects of financial instruments recorded in the consolidated statement of income

The net gains and losses from financial instruments consisted of allowances for doubtful accounts in an amount of € 174 million and foreign currency transactions of € 3 million. In addition, income of € 6 million resulted from the fair value measurement of the CVR and expenses of € 29 million resulted from the fair value measurement of the derivatives embedded in the MEB. Interest income of € 22 million resulted mainly from trade accounts receivables and loans to related parties. Interest expense of € 602 million resulted mainly from financial liabilities.

Effect of derivative instruments designated as hedging instruments on the Statement of Financial Performance


  2009
in million € Gain or loss recognized
in other comprehensive
income (loss)
(effective portion)
Gain or loss reclassified
from accumulated other
comprehensive income
(loss) (effective portion)
Gain or loss
recognized in income
1 The amount of gain or loss recognized in income relates solely to the ineffective portion.
Interest rate contracts 5 - 5
Foreign exchange contracts - 6 2
Derivatives in cash flow hedging relationships 1 - 1 - 3
Foreign exchange contracts     21
Derivatives in fair value hedging relationships     21
Derivatives designated as hedging instruments - 1 - 3 21

  2009
in million € Gain or loss recognized
in other comprehensive
income (loss)
(effective portion)
Gain or loss reclassified
from accumulated other
comprehensive income
(loss) (effective portion)
Gain or loss
recognized in income
1 The amount of gain or loss recognized in income relates solely to the ineffective portion.
Interest rate contracts 5 - 5
Foreign exchange contracts - 6 2
Derivatives in cash flow hedging relationships 1 - 1 - 3
Foreign exchange contracts     21
Derivatives in fair value hedging relationships     21
Derivatives designated as hedging instruments - 1 - 3 21

Gains from derivatives in fair value hedging relationships recognized in income are faced by losses from the underlying transactions in the same amount.

Effect of derivative instruments not designated as hedging instruments on the Statement of Financial Performance


  2009
in million € Gain or loss
recognized in income
Foreign exchange contracts - 22
Derivatives embedded in the MEB - 29
Derivatives not designated as hedging instruments - 51

  2009
in million € Gain or loss
recognized in income
Foreign exchange contracts - 22
Derivatives embedded in the MEB - 29
Derivatives not designated as hedging instruments - 51

The Fresenius Group expects to recognize a net amount of € -4 million of the existing gains and losses deferred in accumulated other comprehensive income (loss) in earnings within the next 12 months.

Gains and losses resulting from interest rate contracts (recognized in income) are recognized as net interest in the consolidated statement of income. Gains and losses from foreign exchange contracts and the corresponding underlying transactions are accounted as cost of sales, selling, general and administrative expenses and net interest. The position other financial result in the consolidated statement of income includes gains and losses from the valuation of the derivatives embedded in the MEB (see note 10, Other financial result).

Market risk

General

The Fresenius Group is exposed to effects related to foreign exchange fluctuations in connection with its international business activities that are denominated in various currencies. In order to finance its business operations, the Fresenius Group issues senior notes, trust preferred securities and commercial papers and enters into mainly long-term credit agreements and euro notes (Schuldscheindarlehen) with banks. Due to these financing activities, the Fresenius Group is exposed to interest risk caused by changes in variable interest rates and the risk of changes in the fair value of statement of financial position items bearing fixed interest rates.

In order to manage the risks of interest rate and foreign exchange rate fluctuations, the Fresenius Group enters into certain hedging transactions with highly rated financial institutions as authorized by the Management Board. Derivative financial instruments are not used for trading purposes.

In general, the Fresenius Group conducts its derivative financial instrument activities under the control of a single centralized department. The Fresenius Group has established guidelines derived from best practice standards in the banking industry for risk assessment procedures and supervision concerning the use of financial derivatives. These guidelines require amongst other things a clear segregation of duties in the areas of execution, administration, accounting and controlling.

The Fresenius Group defines benchmarks for individual exposures in order to quantify interest and foreign exchange risks. The benchmarks are derived from achievable and sustainable market rates. Depending on the individual benchmarks, hedging strategies are determined and implemented.

Earnings of the Fresenius Group were not materially affected by hedge ineffectiveness in the reporting period since the critical terms of the interest and foreign exchange derivatives mainly matched the critical terms of the underlying exposures.

Derivative financial instruments

Foreign exchange risk management

The Fresenius Group has determined the euro as its financial reporting currency. Therefore, foreign exchange translation risks resulting from the fluctuation of exchange rates between the euro and the local currencies, in which the financial statements of the foreign subsidiaries are prepared, have an impact on results of operations and financial positions reported in the consolidated financial statements.

Besides translation risks, foreign exchange transaction risks exist, which mainly relate to transactions such as purchases and sales as well as engineering and services provided by the Fresenius Group which are denominated in foreign currencies. A major part of transaction risks arise from products manufactured in Fresenius Group’s worldwide production sites which are usually denominated in the local currency of the respective manufacturer and are delivered worldwide to various Fresenius Group entities. These intragroup sales are mainly denominated in euros, US dollars and yens. Therefore, Group companies are exposed to changes of the foreign exchange rates between the invoicing currencies and the local currencies in which they conduct their businesses.

Solely for the purpose of hedging existing and foreseeable foreign exchange transaction exposures, the Fresenius Group enters into foreign exchange forward contracts and, on a small scale, foreign exchange options. In order to ensure that no foreign exchange risks result from loans in foreign currencies, the Fresenius Group enters into foreign exchange swap contracts.

As of December 31, 2009, the notional amounts of foreign exchange contracts totaled € 2,442 million. These foreign exchange contracts have been entered into to hedge risks from operational business and in connection with loans in foreign currency. The predominant part of the foreign exchange forward contracts to hedge risks from operational business was recognized as cash flow hedge, while foreign exchange contracts in connection with loans in foreign currencies are partly recognized as fair value hedges. The fair values of cash flow hedges and fair value hedges were € 6 million and € 20 million, respectively.

The hedge-effective portion of changes in the fair value of foreign exchange forward contracts that are designated and qualified as cash flow hedges of forecasted product purchases and sales is reported in accumulated other comprehensive income (loss). These amounts are subsequently reclassified into earnings as a component of cost of sales or as selling, general and administrative expenses in the same period in which the hedged transaction affects earnings.

As of December 31, 2009, the Fresenius Group was party to foreign exchange contracts with a maximum maturity of 40 months.

In order to estimate and quantify the transaction risks from foreign currencies, the Fresenius Group considers the cash flows reasonably expected for the following three months as the relevant assessment basis for a sensitivity analysis. For this analysis, the Fresenius Group assumes that all foreign exchange rates in which the Group had unhedged positions as of reporting date would be negatively impacted by 10 %. By multiplying the calculated unhedged risk positions with this factor, the maximum possible negative impact of the foreign exchange transaction risks on the Group’s results of operations would be € 9 million.

Interest rate risk management

Fresenius Group’s interest rate risks mainly arise from money market and capital market transactions of the Group for financing its business activities.

The Fresenius Group enters into interest rate swaps and, on a small scale, into interest rate options in order to hedge against interest rate exposures arising from long-term borrowings at variable rates by swapping them into fixed rates. For purposes of analyzing the impact of changes in the relevant reference interest rates on Fresenius Group’s results of operations, the Group calculates the portion of financial debt which bears variable interest rates and which has not been hedged by means of interest rate swaps or options against rising interest rates. For this particular part of its liabilities, the Fresenius Group assumes an increase in the reference rates of 0.5 % compared to the actual rates as of the date of the statement of financial position. The corresponding additional annual interest expense is then compared to the net income attributable to Fresenius SE. This analysis shows that an increase of 0.5 % in the relevant reference rates would have an effect of less than 1 % on the consolidated net income attributable to Fresenius SE and Fresenius SE shareholders’ equity.

The Fresenius Group enters into interest rate swaps that are designated as cash flow hedges effectively converting certain variable interest rate payments, resulting from existing loans and Euro Notes (Schuldscheindarlehen) mainly denominated in US dollars or euros, into fixed interest rate payments. The US dollar interest rate swaps with a notional volume of US$ 3,300 million (€ 2,291 million) and a fair value of € -110 million expire at various dates in the years 2010 to 2013. The Euro interest rate swaps with a notional volume of € 407 million and a fair value of € -24 million expire in the years 2011 to 2016. The US dollar interest rate swaps bear an average interest rate of
4.20 % and the Euro interest rate swaps bear an average interest rate of 4.33 %.

Interest payables and interest receivables in connection with the swap agreements are accrued and recorded as an adjustment to the interest expense at each reporting date.

Credit risk

The Fresenius Group is exposed to potential losses in the event of non-performance by counterparties to derivative financial instruments. With respect to derivative financial instruments, it is not expected that any counterparty fails to meet its obligations as the counterparties are highly rated financial institutions. The maximum credit exposure of derivatives is represented by the fair value of those contracts with a positive fair value amounting to € 49 million for foreign exchange derivatives at December 31, 2009. No credit exposure existed from interest rate derivatives. The maximum credit risk resulting from the use of non-derivative financial instruments is defined as the total amount of all receivables. In order to control this credit risk, the Management of the Fresenius Group performs an ageing analysis of trade accounts receivable. For details on the ageing analysis and on the allowance for doubtful accounts, please see note 14, Trade accounts receivable .

Liquidity risk

The liquidity risk is defined as the risk that a company is potentially unable to meet its financial obligations. The Management of the Fresenius Group manages the liquidity of the Group by means of effective working capital and cash management as well as an anticipatory evaluation of refinancing alternatives. The Management of the Fresenius Group believes that existing credit facilities as well as the cash generated by operating activities and additional short-term borrowings are sufficient to meet the Company’s foreseeable demand for liquidity (see note 21, Debt and capital lease obligations).

The following table shows the undiscounted contractual cash flows (including interests) resulting from recognized financial liabilities and the fair value of derivative financial instruments:

in million € up to 1 year 1 to 5 years more than 5 years
1 Future interest payments for financial liabilities with variable interest rates were calculated using the latest interest rates fixed prior to December 31, 2009.
2 The line Mandatory Exchangeable Bonds includes only interests, as the bonds will be exchangeable into shares of FMC-AG & Co. KGaA and not redeemable in cash upon maturity.
Long-term debt and capital lease obligations 1 417 5,543 123
Short-term debt (including accounts receivable securitization program) 302 0 0
Senior Notes 140 1,022 1,800
Mandatory Exchangeable Bonds 2 31 31 0
Trade accounts payable 601
Trust preferred securities 35 473
Derivative financial instruments 28 136 0
Total 1,554 7,205 1,923

in million € up to 1 year 1 to 5 years more than 5 years
1 Future interest payments for financial liabilities with variable interest rates were calculated using the latest interest rates fixed prior to December 31, 2009.
2 The line Mandatory Exchangeable Bonds includes only interests, as the bonds will be exchangeable into shares of FMC-AG & Co. KGaA and not redeemable in cash upon maturity.
Long-term debt and capital lease obligations 1 417 5,543 123
Short-term debt (including accounts receivable securitization program) 302 0 0
Senior Notes 140 1,022 1,800
Mandatory Exchangeable Bonds 2 31 31 0
Trade accounts payable 601
Trust preferred securities 35 473
Derivative financial instruments 28 136 0
Total 1,554 7,205 1,923

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