Volvo’s global operations expose the company to financial risks in the form of interest rate risks, currency risks, credit risks and liquidity risks. Work on financial risks comprises an integrated element of Volvo’s business. Volvo Group strives to minimize these risks by optimizing the Group's capital costs by utilizing economies of scale, minimize negative effects on income as a result of changes in currency or interest rates and to optimize risk exposure. All risks are managed pursuant to Volvo’s established policies in these areas. For further information on Accounting principles for Financial Instruments refer to note 30, Financial Instruments.
Volvo’s risk management related to specific balance sheet items are thus also described in other areas of the Annual Report. Refer to the Note’s instructions.
Interest-rate risks (A)
Interest-rate risk refers to the risk that changed interest-rate levels will affect consolidated earnings and cash flow (cash-flow risks) or the fair value of financial assets and liabilities (price risks).
Matching the interest-fixing terms of financial assets and liabilities reduces the exposure. Interest-rate swaps are used to change/influence the interest-fixing term for the Group’s financial assets and liabilities. Currency interest-rate swaps enable borrowing in foreign currencies from different markets without introducing currency risk. Volvo also has standardized interest-rate forward contracts (futures) and FRAs (forward-rate agreements). Most of these contracts are used to hedge interest-rate levels for short-term borrowing or investments.
Cash-flow risks The effect of changed interest rate levels on future currency and interest-rate flows primarily pertains to the Group’s customer financing operations and net financial items. Customer finance operations measure the degree of matching interest rate fixing on borrowing and lending. The calculation of the matching degree excludes equity, which amounted to between 8 and 10% in the customer finance operations. At year-end 2011, the degree of such matching was 97% (100), which was in line with the Group’s policy. At year-end 2011, in addition to the assets in its customer-financing operations, Volvo’s interest- bearing assets consisted primarily of cash, cash equivalents and liquid assets invested in short-term interest-bearing securities. The objective is to achieve an interest-fixing term of three months for the liquid assets in Volvo’s industrial operations through the use of derivatives. On December 31, 2011, after taking derivatives into account, the average interest on these assets was 1.9% (2.0). After taking derivatives into account, outstanding loans had interest terms corresponding to an interest-rate fixing term of three months and the average interest at year-end amounted to 4.1% (4.3), including Volvo’s credit costs.
Price risks (C) Exposure to price risks as result of changed interest-rate levels refers to financial assets and liabilities with a longer interest-rate fixing term (fixed interest).
The following table* (D) shows the effect on income before taxes in Industrial Operations financial net position , including pensions and similar net obligations, if interest rates were to increase by 1 percentage point, (100 basis points) assuming an average interest-rate fixed term of three months.
Net financial position
Impact on earnings before tax
Impact on Net financial position
if interest rate rises 1% (Interest-rate risks) (A)
if SEK rises 10% (Currency risks) (B)
* The Note’s sensitivity analysis on interest rate risks is based on simplified assumptions. It is not unreasonable for market interest rates to change by 1 percentage point (100 basis points) on an annual basis. However, in reality, these rates often rise or decline at different points in time. The sensitivity analysis also assumes a parallel deferment of the return curve, and that the interest rates on assets and liabilities will be equally impacted by changes in market interest rates. Accordingly, the impact of real interest-rate changes may differ from the analysis presented above (Table D).
The content of the recognized balance sheet may be affected by changes in different exchange rates. Currency risks in Volvo’s operations are related to changes in the value of contracted and expected future payment flows (commercial currency exposure), changes in the value of loans and investments (financial currency exposure) and changes in the value of assets and liabilities in foreign subsidiaries (currency exposure of shareholders’ equity).
The aim of Volvo’s currency risk management is to secure cash flow from firm flows through currency hedges pursuant to the established currency policy, and to minimize the exposure of financial items in Volvo’s balance sheet. Below is a presentation on how this work is conducted for commercial and financial currency exposure, and for currency exposure of shareholders’ equity.
Commercial currency exposure Transaction exposure from commercial flows Volvo uses forward contracts and currency options to hedge the value of future payment flows in foreign currencies. Volvo only hedges firm flows, most of which are realized within six months. The hedged amount of firm flows for all periods fall within the framework of Volvo’s currency policy.
The table (F) shows outstanding forward and option contracts for the hedging of commercial currency risks. The table Operating net flow per currency shows commercial net flows per currency (transactional flows net).
(F) The Volvo Group’s outstanding forward contracts and options contracts for hedging of commercial currency risks
Due date 2012
Due date 2013
Due date 2014
Total local currency
Average contract rate
Market value of outstanding forward contracts SEK M
Translation exposure during the consolidation of operating income in foreign subsidiaries In conjunction with the translation of operating income in foreign subsidiaries, Volvo’s earnings are impacted if currency rates change. Volvo does not hedge this risk. For more information on currency hedging of equity see below.
Sensitivity analysis – currencies* The tables below show the impact on sales and operating income for Volvo if key currencies fluctuate. The sensitivity analysis include the transaction impact from commercial flows and the translation impact during the consolidation of foreign subsidiaries.
Financial currency exposure Loans and investments in the Group’s subsidiaries are performed mainly through Volvo Treasury in local currencies, which minimizes individual companies’ financial currency exposure. Volvo Treasury uses various derivatives to facilitate lending and borrowing in different currencies without increasing the company’s risk. The financial net position of the Volvo Group is affected by exchange-rate fluctuations since financial assets and liabilities are distributed among Group companies that conduct their operations using different currencies.
The Impact on Net financial position table (D) shows the impact on earnings before tax of Industrial operations financial net position, including pensions and similar net obligations, if the SEK were to strengthen by 10%. (D)
Currency exposure of equity The consolidated value of assets and liabilities in foreign subsidiaries is affected by current exchange rates in conjunction with the translation of assets and liabilities to Swedish kronor. To minimize currency exposure of equity, the size of equity in foreign subsidiaries is continuously optimized with respect to commercial and legal conditions. Currency hedging of equity may occur in cases where a foreign subsidiary is considered overcapitalized. Net assets in foreign subsidiaries and associated companies amounted at year-end 2011 to SEK 67.8 billion (60.3). The remaining loans used as hedging instruments have expired in 2011. For more information on hedging of net investments in foregin operations recognized in equity refer to note 30 Financial Instruments.The need to undertake currency hedging relating to investments in associated companies and other companies is assessed on a case-by-case basis.
Sensitivity analysis Currency effect on net sales from inflows in foreign currency and translation effect when consolidating net sales in foreign subsidiares (G).
Sensitivity analysis Currency effect on operating income from net flows in foreign currency and translation effect when consolidating operating income in foreign subsidiaries (H).
Volvo’s currency review When Volvo communicates the currency impact on operating income, the following factors are included:
(I) Currency impact on operating income SEK billion
Net flows in foreign currency
Realized gains and losses on hedging contracts
Unrealized gains and losses on hedging contracts
Unrealized gains and losses on receivables and liabilities in foreign currency
Currency effect from devaluation in Venezuela
Translation effect on operating income in foreign subsidiaries
Total currency impact on operating income
Currency impact on Net flows in foreign currency and Translation effect on operating income in foreign subsidiaries are detailed in table (H) in key currencies for Volvo.
* The Note’s sensitivity analysis on currency rate risks is based on simplified assumptions. It is not unreasonable for the value in SEK to strengthen by 10% in relation to other currencies. In reality, currencies usually do not change in the same direction at any given time, so the actual effect of exchange-rate changes may differ from the sensitivity analysis. Please refer to table (D, GH)
Credit risks are defined as the risk that Volvo does not receive payment for recognized accounts receivable and customer-financing receivables (commercial credit risk), that Volvo’s investments are unable to be realized (financial credit risk) and that potential profit is not realized due to the counterparty not fulfilling its part of the contract when using derivative instruments (financial counterparty risk).
The objective of the Volvo Group Credit Policy is to define and measure the credit exposure and control the risk of losses deriving from credits to customers, credits to suppliers, counter party risks and Customer Dealer Financing activities.
Commercial credit risk Volvo’s credit granting is steered by Group-wide policies and customer-classification rules. The credit portfolio should contain a sound distribution among different customer categories and industries. The credit risks are managed through active credit monitoring, follow-up routines and, where applicable, product repossession. Moreover, regular monitoring ensures that the necessary allowances are made for incurred losses on doubtful receivables. In Notes 15 and 16, ageing analyses are presented of customer finance receivables overdue and accounts receivables overdue in relation to the reserves made.
The credit portfolio of Volvo’s customer-financing operations amounted at December 31, 2011, to approximately net SEK 79 billion (73). The credit risk of this portfolio is distributed over a large number of retail customers and dealers. Collaterals are provided in the form of the financed products. In the credit granting Volvo strives for a balance between risk exposure and expected return.
Financial credit risk The Volvo Group’s financial assets are largely managed by Volvo Treasury and invested in the money and capital markets. All investments must meet the requirements of low credit risk and high liquidity. According to Volvo’s credit policy, counterparties for investments and derivative transactions should have a rating of A or better from one of the well-established credit rating institutions.
Financial counterparty risk The use of derivatives involves a counterparty risk, in that a potential gain will not be realized if the counterparty fails to fulfill its part of the contract. To reduce the exposure, master netting agreements are signed, wherever possible, with the counterparty in question. Counterparty risk exposure for futures contracts is limited through daily or monthly cash transfers corresponding to the value change of open contracts. The estimated gross exposure to counterparty risk relating to futures, interest-rate swaps and interest-rate forward contracts, options and commodities contracts amounted at December 31, 2011, to 281 (331), 4,024 (3,539 ), 284 (190) and 68 (168).
Liquidity risk is defined as the risk that Volvo would be unable to finance or refinance its assets or fulfill its payment obligations.
Volvo assures itself of sound financial preparedness by always keeping a certain percentage of its sales in liquid assets. A sound balance between short and long-term borrowing, as well as borrowing preparedness in the form of overdraft facilities, are intended to meet its long-term financing needs.
The adjacent graph (J) shows expected future cash-flows including derivatives related to financial liabilities. Capital flow refers to expected payments of loans and derivatives, see note 22. Expected interest flow refers to the future interest payments on loans and derivatives based on interest rates expected by the market. The interest flow is recognized within cash flow from operating activities.
In addition to derivatives included in capital flow in the table there are also derivatives related to financial liabilities reported as assets, which are expected to give a future capital flow of SEK 0.8 bn and a future interest flow of SEK 3.4 bn.
Read more about the maturity structure concerning bond loans and other loans, as well as granted but unutilized credit facilities in Note 22.
Read more about contractual term analyses of Volvo’s future rental payments from non-annullable financial and operational lease contracts in Note 14.
Future cash-flow including derivatives related to non-current and current financial liabilities (J)