| | COMMODITIES:
The Group has only a very limited exposure to price risk related to
anticipated purchases of certain commodities used as raw materials. A change in
those prices may alter the gross margin of a specific business, but generally
by not more than 10% of the margin and thus below the Group’s risk management
tolerance levels. Accordingly, it does not enter into significant commodity futures,
forward and option contracts to manage fluctuations in prices of anticipated purchases.
INTEREST RATES: The Group manages its net
exposure to interest rate risk through the proportion of fixed rate debt and variable
rate debt in its total debt portfolio. To manage this mix, Novartis may enter
into interest rate swap agreements, in which it exchanges periodic payments based
on a notional amount and agreed-upon fixed and variable interest rates.
EQUITY RISK: The Group purchases equities
as investments of its liquid funds. As a policy, it limits its holdings in an
unrelated company to less than 5% of its liquid funds. Potential investments are
thoroughly analyzed in respect to their past financial track record (mainly cash
flow return on investment), their market potential, their management and their
competitors. Call options are written on equities that the Group owns, and put
options are written on equities which the Group wants to buy and for which cash
has been reserved. MANAGEMENT
SUMMARY: Use of derivative financial instruments did not have a material
impact on the Group’s financial position at December 31, 2005 and 2004 or its
results of operations for the years ended December 31, 2005 and 2004. | | VALUE
AT RISK: The Group uses a value at risk (VAR) computation to estimate
the potential ten-day loss in the fair value of its interest- rate-sensitive financial
instruments, the loss in pre-tax earnings of its foreign currency price-sensitive
derivative financial instruments as well as the potential ten-day loss of its
equity holdings. It uses a ten-day period because of an assumption that not all
positions could be undone in a single day given the size of the positions. The
VAR computation includes the Group’s debt, shortterm and long-term investments,
foreign currency forwards, swaps and options as well as anticipated transactions.
Foreign currency trade payables and receivables as well as net investments in
foreign subsidiaries are excluded from the computation.
The VAR estimates are made assuming normal market conditions, using a 95% confidence
interval. The Group uses a “Delta Normal” model to determine the observed inter-relationships
between movements in interest rates, stock markets and various currencies. These
inter-relationships are determined by observing interest rate, stock market movements
and forward currency rate movements over a 60-day period for the calculation of
VAR amounts. The estimated potential ten-day loss
in pre-tax earnings from the Group’s foreign currency instruments, the estimated
potential ten-day loss on its equity holdings, and the estimated potential tenday
loss in fair value of its interest rate sensitive instruments, primarily debt
and investments of liquid funds under normal market conditions, as calculated
in the VAR model, are the following:
The
average, high, and low VAR amounts for 2005 are as follows:
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