16 Financial instruments

(This note should be read in conjunction with the Finance Director's review)

Carrying values and fair values of financial instruments
The carrying values of the Group's financial instruments (together with non-financial instruments for reconciling purposes) are analysed as follows:
  2007
    Financial instruments    
  Notes Derivative
£m		 Non-
derivative
£m		 Non-financial
instruments
£m		 Total
£m
Assets:          
Unlisted non-current asset investments 1,2 10 — 57 — 57
Other non-current assets   — — 4,149 4,149
Trade and other receivables: 3          
Trade receivables and similar items 1 12 — 1,211 — 1,211
Other non-derivative financial assets 1 12 — 321 — 321
Non-financial instruments 12 — — 1,053 1,053
Other financial assets 4   514 — — 514
Short-term investments 1,3   — 40 — 40
Cash and cash equivalents: 3          
Cash at bank and in hand 13 — 1,265 — 1,265
Short-term deposits 13 — 632 — 632
Other current assets   — — 2,217 2,217
    514 3,526 7,419 11,459
Liabilities:          
Borrowings          
– current 4 14 — (34) — (34)
– non-current 4 14 — (1,030) — (1,030)
Other financial liabilities: 4          
Financial RRSPs   — (315) — (315)
B Shares   — (16) — (16)
Other   (57) — — (57)
Trade and other payables: 3          
Trade payables and similar items 15 — (1,872) — (1,872)
Other non-derivative financial liabilities 15 — (315) — (315)
Non-financial instruments 15 — — (3,104) (3,104)
Other liabilities   — — (1,167) (1,167)
    (57) (3,582) (4,271) (7,910)
Net assets/(liabilities)   457 (56) 3,148 3,549
 
Carrying values and fair values of financial instruments (cont'd)
  2006
    Financial instruments    
  Notes Derivative
£m		 Non-
derivative
£m		 Non-financial
instruments
£m		 Total
£m
Assets:          
Unlisted non-current asset investments 1,2 10 — 51 — 51
Other non-current assets   — — 3,569 3,569
Trade and other receivables: 3          
Trade receivables and similar items 1 12 — 1,210 — 1,210
Other non-derivative financial assets 1 12 — 300 — 300
Non-financial instruments 12 — — 955 955
Other financial assets 4   644 — — 644
Short-term investments 1,3   — 34 — 34
Cash and cash equivalents: 3          
Cash at bank and in hand 13 — 757 — 757
Short-term deposits 13 — 1,428 — 1,428
Other current assets   — — 1,850 1,850
    644 3,780 6,374 10,798
Liabilities:          
Borrowings – current 4 14 — (400) — (400)
– non-current 4 14 — (990) — (990)
Other financial liabilities: 4          
Financial RRSPs   — (324) — (324)
B Shares   — (13) — (13)
Other   (36) — — (36)
Trade and other payables: 3          
Trade payables and similar items 15 — (1,735) — (1,735)
Other non-derivative financial liabilities 15 — (282) — (282)
Non-financial instruments 15 — — (2,498) (2,498)
Other liabilities   — — (1,795) (1,795)
    (36) (3,744) (4,293) (8,073)
Net assets/(liabilities)   608 36 2,081 2,725

The fair value of a financial instrument is the price at which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction. Fair values have been determined with reference to available market information at the balance sheet date, using the methodologies discussed below.

1 Loans and receivables.
2 These primarily comprise floating rate convertible loan stock. The conversion conditions are such that fair value approximates to the book value.
3 Fair values are assumed to approximate to cost either due to the short-term maturity of the instruments or because the interest rate of the investments is reset after periods not exceeding six months
4 Where available, market values have been used to determine fair values. Where market values are not readily available (principally in respect of derivatives, borrowings and financial RRSPs), fair values have been estimated by discounting expected future cash flows using prevailing interest rate curves. Amounts denominated in foreign currencies are valued at the exchange rate prevailing at the balance sheet date.

Fair values equate to book values for both 2007 and 2006, with the following exceptions:
  Book value
£m		 2007
Fair value
£m		 Book value
£m		 2006
Fair value
£m
Borrowings        
– current (34) (34) (400) (402)
– non-current (1,030) (1,058) (990) (1,030)
Financials RRSPs (315) (340) (324) (347)
The carrying values of financial assets and liabilities by category, as defined by IAS 39 Financial Instruments: Recognition and Measurement, are as follows:
  2007
£m		 2006
£m
Assets    
Held for trading 514 644
Loans and receivables 1,629 1,595
Available for sale 632 1,428
Cash 1,265 757
Liabilities    
Held for trading (57) (36)
Financial liabilities at amortised cost (3,582) (3,744)
  401 644
Carrying values of other financial assets and liabilities
  Foreign
exchange
contracts
£m		 Commodity
contracts
£m		 Interest rate
contracts
£m		 Financial
RRSPs
£m		 B Shares
£m		 Total
£m
At December 31, 2007            
Assets 433 39 42 — — 514
Liabilities (54) — (3) (315) (16) (388)
  379 39 39 (315) (16) 126
At December 31, 2006            
Assets 578 39 27 — — 644
Liabilities (24) — (12) (324) (13) (373)
  554 39 15 (324) (13) 271
Other financial liabilities are analysed as follows:
  2007
£m		 2006
£m
Current liabilities (85) (37)
Non-current liabilities (303) (336)
  (388) (373)

Foreign exchange and commodity financial instruments

The Group uses various financial instruments to manage its exposure to movements in foreign exchange rates. The Group uses commodity swaps to manage its exposure to movements in the price of commodities (jet fuel and base metals). From January 1, 2005, the Group has not included foreign exchange or commodity financial instruments in any cash flow hedging relationships for accounting purposes. To hedge the currency risk associated with a borrowing denominated in US dollars, the Group has currency derivatives designated as part of fair value hedges.

 
Movements in the fair values of foreign exchange and commodity instruments were as follows:
Foreign exchange instruments Commodity instruments
  Total
£m		 Included in
transition
hedging
reserve
£m		 Included in
income
statement
£m		 Total
£m		 Included in
transition
hedging
reserve
£m		 Included in
income
statement
£m
At January 1, 2006 228 538   31 5  
Fair value changes to derivative contracts not in accounting hedging relationships 1 696 — 696 34 — 34
Fair value changes to fair value hedges 1,2 (26) — (26) — — —
Fair value of contracts settled (344) — — (26) — —
Transferred to revenue — (284) 284 — (5) 5
At January 1, 2007 554 254   39 —  
Fair value changes to derivative contracts not in accounting hedging relationships 1 215 — 215 36 — 36
Fair value changes to fair value hedges 1,2 (6) — (6) — — —
Fair value of contracts settled (384) — — (36) — —
Transferred to revenue — (149) 149 — — —
At December 31, 2007 379 105   39 —  

1 Included in financing.
2 Gain on related hedged items £6m (2006 £26m).

Interest rate financial instruments

The Group uses interest rate swaps, forward rate agreements and interest rate caps to manage its exposure to movements in interest rates. Where the effectiveness of the hedge relationship in a cash flow hedge is demonstrated, changes in the fair value that are deemed effective are included in the hedging reserve and released to match actual payments on the hedged item.

Movements in the fair values of interest rate financial instruments were as follows:
  Total
£m		 Included in
fair value
hedging
relationships
£m		 Other
interest rate
financial
instruments
£m		 Included in
income
statement
£m
At January 1, 2006 62 69 (7)  
Changes deemed ineffective for cash flow hedge accounting purposes 1 4 — 4 4
Other changes 1,2 (51) (51) — (51)
At January 1, 2007 15 18 (3)  
Other changes 1,2 24 24 — 24
At December 31, 2007 39 42 (3)  
1 Included in financing.
2 Movement on related hedged items £24m loss (2006 £51m gain)

Financial risk and revenue sharing partnerships (RRSPs)

The Group has financial liabilities arising from financial RRSPs. These financial liabilities are valued at each reporting date using the amortised cost method. This involves calculating the present value of the forecast cash flows of the arrangements using the internal rate of return at the inception of the arrangements as the discount rate.

Movements in the amortised cost values of financial RRSPs were as follows:
  2007
£m		 2006
£m
At January 1 324 423
Cash paid to partners (55) (87)
Exchange adjustments direct to reserves 7 —
Financing charge 1 26 27
Excluded from underlying profit:    
Exchange adjustments 1 (7) (42)
Restructuring of financial RRSP agreements and changes in forecast payments 1 20 3
At December 31 315 324

1 Included in financing.

Risk management policies and hedging activities

The principal financial risks to which the Group is exposed are: foreign currency exchange rate risk; interest rate risk; and commodity price risk. The Board has approved policies for the management of these risks.

Foreign currency exchange rate risk - The Group has significant cash flows (most significantly US dollars, followed by the Euro) denominated in currencies other than the functional currency of the relevant trading entity. To manage its exposures to changes in values of future foreign currency cash flows, so as to maintain relatively stable long-term foreign exchange rates on settled transactions, the Group enters into derivative forward foreign currency transactions. For accounting purposes, these derivative contracts are not designated as hedging instruments.

The Group also has exposures to the fair values of non-derivative financial instruments denominated in foreign currencies. To manage the risk of changes in these fair values, the Group enters into derivative forward foreign exchange contracts, which are designated as fair value hedges for accounting purposes.

The Group regards its interests in overseas subsidiary companies as long-term investments. The Group aims to match its translational exposures by matching the currencies of assets and liabilities. Where appropriate, foreign currency financial liabilities may be designated as hedges of the net investment.

Interest rate risk - The Group's interest rate risk is primarily in relation to its fixed rate borrowings (fair value risk) and floating rate borrowings (cash flow risk). Interest rate derivatives are used to manage the overall interest rate profile within the Group policy, which is to maintain a higher proportion of net debt at fixed rates of interest having regard to the prevailing interest rate outlook. These are designated as either fair value or cash flow hedges as appropriate.

Commodity risk - The Group has exposures to the price of jet fuel and base metals arising from business operations. To minimise its cash flow exposures to changes in commodity prices, the Group enters into derivative commodity transactions. For accounting purposes, these derivative contracts are not designated as hedging instruments.

Other price risk - The Group's cash equivalent balances represent investments in money market instruments, with a term of up to one month. The Group does not consider that these are subject to significant price risk.

Liquidity risk - The Group's policy is to hold financial investments and maintain undrawn committed facilities at a level sufficient to ensure that the Group has available funds to meet its medium-term capital and funding obligations and to meet any unforeseen obligations and opportunities. The Group holds cash and short-term investments, which together with the undrawn committed facilities, enable the Group to manage its liquidity risk.

Credit risk - The Group is exposed to credit risk to the extent of non-payment by either its customers or the counterparties of its financial instruments. The Group has credit policies covering both trading and financial exposures. At the balance sheet date, there were no significant concentrations of credit risk. The maximum exposure to credit risk at the balance sheet date is represented by the carrying value of each financial asset, including derivative financial instruments.

Derivative financial instruments
The nominal amounts and fair values of derivative financial instruments are as follows, analysed by year of expected maturity:
  2007
  Expected maturity Fair value
  Nominal
amount
£m		 Within
one year
£m		 Between one
and two years
£m		 Between two
and five years
£m		 After
five years
£m		 Assets
£m		 Liabilities
£m
Foreign exchange contracts:              
Fair value hedges (280) — — (105) (175) — (27)
Non-hedge accounted 5,168 2,135 1,816 1,217 — 433 (27)
Interest rate contracts:              
Fair value hedges 751 — — 594 157 42 —
Non-hedge accounted 74 20 18 16 20 — (3)
Commodity contracts:              
Non-hedge accounted 166 91 55 20 — 39 —
  5,879 2,246 1,889 1,742 2 514 (57)
 
  2006
  Expected maturity Fair value
  Nominal
amount
£m		 Within
one year
£m		 Between one
and two years
£m		 Between two
and five years
£m		 After
five years
£m		 Assets
£m		 Liabilities
£m
Foreign exchange contracts:              
Fair value hedges (280) — — (105) (175) — (21)
Non-hedge accounted 5,473 1,861 1,964 1,648 — 578 (3)
Interest rate contracts:              
Fair value hedges 1,069 313 — 596 160 27 (9)
Non-hedge accounted 98 21 21 34 22 — (3)
Commodity contracts:              
Non-hedge accounted 152 68 49 35 — 39 —
  6,512 2,263 2,034 2,208 7 644 (36)

As described above, all derivative financial instruments are entered into for risk management purposes, although these may not be designated into hedging relationships for accounting purposes.

Derivative financial instruments related to foreign exchange risks are denominated in the following currencies:
  2007
Currencies purchased forward
  Sterling
£m		 US dollar
£m		 Euro
£m		 Other
£m		 Total
£m
Currencies sold forward:          
Sterling — 280 — 30 310
US dollar 5,136 — 922 431 6,489
Euro — — — 497 497
Other 3 12 151 98 264
 
  2006
Currencies purchased forward
  Sterling
£m		 US dollar
£m		 Euro
£m		 Other
£m		 Total
£m
Currencies sold forward:          
Sterling — 280 — 16 296
US dollar 5,543 — 466 351 6,360
Euro — — — 241 241
Other 3 22 77 29 131
           
Other derivative financial instruments are denominated in the following currencies:
  2007
£m		 2006
£m
Sterling 20 22
US dollar 470 484
Euro 500 813
Other — —
Non-derivative financial instruments
Non-derivative financial instruments are denominated in the following currencies:
  2007
  Sterling
£m		 US dollar
£m		 Euro
£m		 Other
£m		 Total
£m
Assets:          
Unlisted non-current investments 46 6 2 3 57
Trade receivables and similar items 233 720 133 125 1,211
Other non-derivative financial assets 150 68 40 63 321
Short-term investments 40 — — — 40
Cash at bank and in hand 161 376 608 120 1,265
Short-term deposits 319 293 3 17 632
  949 1,463 786 328 3,526
Liabilities:          
Borrowings          
– current (5) (3) (1) (25) (34)
– non-current (203) (290) (537) — (1,030)
Financial RRSPs — (315) — — (315)
B Shares (16) — — — (16)
Trade payables and similar items (959) (495) (248) (170) (1,872)
Other non-derivative financial liabilities (148) (85) (35) (47) (315)
  (1,331) (1,188) (821) (242) (3,582)
  (382) 275 (35) 86 (56)
 
  2006
  Sterling
£m		 US dollar
£m		 Euro
£m		 Other
£m		 Total
£m
Assets:          
Unlisted non-current investments 46 1 2 2 51
Trade receivables and similar items 270 728 114 98 1,210
Other non-derivative financial assets 113 90 44 53 300
Short-term investments 34 — — — 34
Cash at bank and in hand 105 255 335 62 757
Short-term deposits 1,250 157 8 13 1,428
  1,818 1,231 503 228 3,780
Liabilities:          
Borrowings          
– current (7) (41) (341) (11) (400)
– non-current (206) (285) (498) (1) (990)
Financial RRSPs — (324) — — (324)
B Shares (13) — — — (13)
Trade payables and similar items (890) (512) (236) (97) (1,735)
Other non-derivative financial liabilities (158) (63) (5) (56) (282)
  (1,274) (1,225) (1,080) (165) (3,744)
  544 6 (577) 63 36
Currency exposures
The Group's actual currency exposures after taking account of derivative foreign currency contracts, which are not designated as hedging instruments for accounting purposes are as follows:
  2007
Functional currency of Group operation Sterling
£m		 US dollar
£m		 Euro
£m		 Other
£m		 Total
£m
Sterling — 3 — 2 5
US dollar 6 — — 6 12
Euro — 5 — — 5
Other — 4 9 12 25
 
  2006
Functional currency of Group operation Sterling
£m		 US dollar
£m		 Euro
£m		 Other
£m		 Total
£m
Sterling — 3 1 (1) 3
US dollar 4 — — 2 6
Euro (1) — — — (1)
Other 1 7 7 7 22
Ageing beyond contractual due date
The ageing beyond contractual due date of the Group's financial assets is:
  2007
  Within
terms
£m		 Up to
three months
overdue
£m		 Between
three months
and one year
overdue
£m		 More than
one year
overdue
£m		 Total
£m
Assets:          
Unlisted non-current asset investments 57 — — — 57
Trade receivables and similar items 973 186 52 — 1,211
Other non-derivative financial assets 296 8 17 — 321
Other financial assets 514 — — — 514
Short-term investments 40 — — — 40
Cash at bank and in hand 1,265 — — — 1,265
Short-term deposits 632 — — — 632
  3,777 194 69 — 4,040
 
  2006
  Within
terms
£m		 Up to
three months
overdue
£m		 Between
three months
and one year
overdue
£m		 More than
one year
overdue
£m		 Total
£m
Assets:          
Unlisted non-current asset investments 51 — — — 51
Trade receivables and similar items 976 208 26 — 1,210
Other non-derivative financial assets 263 20 17 — 300
Other financial assets 644 — — — 644
Short-term investments 34 — — — 34
Cash at bank and in hand 757 — — — 757
Short-term deposits 1,428 — — — 1,428
  4,153 228 43 — 4,424
Contractual maturity analysis
  2007
  Gross cash flows    
  Within
one year
£m		 Between one
and two years
£m		 Between two
and five years
£m		 After
five years
£m		 Discounting
£m		 Carrying
value
£m
Borrowings:            
Unsecured bank loans (26) (1) (1) — — (28)
Other unsecured (3) — — — — (3)
Unsecured bond issues (56) (56) (773) (432) 317 (1,000)
Secured bank loans (1) (1) (26) — 4 (24)
Other secured (6) (3) — (1) 1 (9)
  (92) (61) (800) (433) 322 (1,064)
Other:            
Trade payables and similar items (1,862) (2) (7) (1) — (1,872)
Derivative financial liabilities 1 (13) (2) (4) 20 (58) (57)
Financial RRSPs (38) (34) (201) (141) 99 (315)
B Shares (16) — — — — (16)
Other non-derivative financial liabilities (271) (1) (29) (14) — (315)
  (2,200) (39) (241) (136) 41 (2,575)
  (2,292) (100) (1,041) (569) 363 (3,639)
 
  2006
  Gross cash flows    
  Within
one year
£m		 Between one
and two years
£m		 Between two
and five years
£m		 After
five years
£m		 Discounting
£m		 Carrying
value
£m
Borrowings:            
Unsecured bank loans (18) (1) (2) — — (21)
Other unsecured — (1) — — — (1)
Unsecured bond issues (412) (54) (755) (460) 389 (1,292)
Secured bank loans (40) (1) (28) — 7 (62)
Other secured (9) (5) (3) (1) 4 (14)
  (479) (62) (788) (461) 400 (1,390)
Other:            
Trade payables and similar items (1,735) — — — — (1,735)
Derivative financial liabilities 1 (17) (12) (10) (21) 24 (36)
Financial RRSPs (41) (36) (196) (170) 119 (324)
B Shares (13) — — — — (13)
Other non-derivative financial liabilities (247) — — (35) — (282)
  (2,053) (48) (206) (226) 143 (2,390)
  (2,532) (110) (994) (687) 543 (3,780)

1 Foreign exchange contract and interest rate contract liability
Interest rate risk
In respect of income earning financial assets and interest bearing financial liabilities, the following table indicates their effective interest rates and the periods in which they reprice. The value shown is the carrying amount.
      2007
Period in which interest rate reprices
  Effective
interest rate
%		 Total
£m		 6 months
or less
£m		 6-12 months
£m		 1-2 years
£m		 2-5 years
£m		 More than
5 years
£m
Short-term investments 1 5.5913% 40 14 6 — 12 8
Cash at bank and in hand 2   1,265 1,265 — — — —
Short-term deposits 3   632 632 — — — —
Unsecured bank loans              
€4m floating rate loan EURIBOR +1.2 (3) (3) — — — —
Overdrafts 4   (25) (25) — — — —
Effect of other interest rate swaps 1.2277% — 54 — (18) (16) (20)
Other unsecured              
South Korean Won floating rate loan KRW LIBOR +0.9 (2) (2) — — — —
Other loan 2008 (interest rate nil) 0.0000% (1) (1) — — — —
Unsecured bond issues              
7 3/8% Notes 2016 £200m 7.3750% (200) — — — — (200)
5.84% Notes 2010 US$187m 5.8400% (97) — — — (97) —
Effect of interest rate swaps USD LIBOR +1.159 — (97) — — 97 —
6.38% Notes 2013 US$230m 6.3800% (123) — — — — (123)
Effect of interest rate swaps USD LIBOR +1.26 — (123) — — — 123
6.55% Notes 2015 US$83m 6.5500% (46) — — — — (46)
Effect of interest rate swaps USD LIBOR +1.24 — (46) — — — 46
4 1/2% Notes 2011 €750m 4.5000% (534) — — — (534) —
Effect of interest rate swaps GBP LIBOR +0.911 — (534) — — 534 —
Secured bank loans              
US$ floating rate loan USD LIBOR +0.53 (24) (24) — — — —
Other secured              
Obligations under finance leases payable 6.0183% (9) (2) (3) (3) — (1)
    873 1,108 3 (21) (4) (213)
 
      2006
Period in which interest rate reprices
  Effective
interest rate
%		 Total
£m		 6 months
or less
£m		 6-12 months
£m		 1-2 years
£m		 2-5 years
£m		 More than
5 years
£m
Short-term investments 1 4.8374% 34 15 5 — 8 6
Cash at bank and in hand 2   757 757 — — — —
Short-term deposits 3   1,428 1,428 — — — —
Unsecured bank loans              
€6m floating rate loan EURIBOR +1.2 (4) (4) — — — —
€5m fixed rate loan 4.1200% (3) — (3) — — —
Overdrafts 4   (14) (14) — — — —
Effect of other interest rate swaps 1.1392% — 78 — (21) (35) (22)
Other unsecured              
Other loan 2008 (interest rate nil) 0.0000% (1) — — (1) — —
Unsecured bond issues              
6 3/8% Notes 2007 €500m 6.3750% (337) (337) — — — —
Effect of interest rate swaps GBP LIBOR + 0.866 — — — — — —
7 3/8% Notes 2016 £200m 7.3750% (200) — — — — (200)
5.84% Notes 2010 US$187m 5.8400% (96) — — — (96) —
Effect of interest rate swaps USD LIBOR + 1.159 — (96) — — 96 —
6.38% Notes 2013 US$230m 6.3800% (121) — — — — (121)
Effect of interest rate swaps USD LIBOR + 1.26 — (121) — — — 121
6.55% Notes 2015 US$83m 6.5500% (44) — — — — (44)
Effect of interest rate swaps USD LIBOR + 1.24 — (44) — — — 44
4 1/2% Notes 2011 €750m 4.5000% (494) — — — (494) —
Effect of interest rate swaps GBP LIBOR + 0.911 — (494)