[41] Derivative financial instruments 

Merck uses derivative financial instruments exclusively to hedge currency and interest rate positions, and thereby reduce foreign exchange and interest rate risks. Foreign currency risks from recognized transactions are largely hedged. Merck currently uses marketable forward exchange contracts, interest rate futures, interest rate swaps and currency options as hedging instruments. Depending on the nature of the hedging transaction, changes in the fair values of hedged items are disclosed in the income statement either in the operating result or, in the case of financial transactions, in the financial result.

The strategy to hedge interest rate and foreign exchange rate fluctuations arising from future transactions is set by a Merck Group financial risk committee, which meets on a regular basis. A review period of up to 36 months normally serves as the basis for entering into currency derivative contracts. Extensive guidelines regulate the use of derivatives. There is a ban on speculation. Derivative transactions are subject to continuous risk management procedures. Trading, settlement and control functions are strictly separated. Derivative financial contracts are only entered into with banks that have a good credit rating. Related default risks are continuously monitored.

The following derivative financial positions were held as of the balance sheet date:

The fair values for derivatives stated here does not include accrued interest (clean price).

The nominal volume is the aggregate of all buy and sell amounts relating to derivative contracts. The fair values result from the valuation of open positions at market prices, ignoring any opposite movements in the value of the underlyings. They correspond to the income or expenses which would result if the derivatives contract were closed out as of the balance sheet date. Transactions are recognized at fair value on the basis of quoted prices or current market data provided by a recognized information service.

The maturity structure of the hedging transactions (nominal volume) is as follows as of the balance sheet date:

The forward exchange contracts that are entered into to reduce the exchange rate risk with a total nominal volume of € 6,180.4 million and currency options with a total nominal volume of € 709.8 million primarily serve to hedge intercompany financing in foreign currency as well as to hedge future cash flows. These mainly served to hedge fluctuations in the exchange rates of the U.S. dollar (€ 4,483.5. million), the Swiss franc (€ 432.1 million), the Japanese yen (€ 758.7 million) and the Taiwanese dollar (€ 306.2 million).

Future transactions are only in a cash flow hedging relationship if the occurrence can be assumed to be highly probable. The nominal volume of hedged future transactions amounted to € 2,829.8 million (2010: € 3,613.5 million) as of the balance sheet date and related to both the hedging of future sales in U.S. dollars, Taiwanese dollars and Japanese yen and costs in Swiss francs as well as hedging of future interest rate risks in euros. The occurrence of hedged foreign exchange items is expected within the next 36 months. Moreover, we use forward exchange contracts to hedge financial investments and borrowings in foreign currency and designate them as cash flow hedges. In addition, to refinance bonds maturing in 2012 and 2015, we entered into forward interest rate swap contracts with a nominal value of € 750 million to hedge the current interest rate level. The measurement thereof is disclosed in equity at 100% effectiveness. In addition, interest rate hedge contracts with a nominal volume of € 250 million for bonds due in 2012 were fully recognized as an expense since refinancing is no longer expected. The resulting expenses from the fair value of the hedge amounting to €14.8 million were reported in the financial result. During the fiscal year, expenses of € 50.1 million (2010: income of € 125.3 million) from the fair value measurement of derivatives were recognized in equity. € 12.3 million (2010: € 17.2 million) was transferred from equity and recognized as an expense (2010: expense).

The interest expense of the euro benchmark bond, which was issued in 2005 with a volume of € 500 million and a coupon of 3.75% was variabilized to the six-month Euribor through interest rate swaps and is measured as a fair value hedge. In 2011, the fair value measurement of the bond led to income of € 10.0 million (2010: income of € 0.2 million). This was offset by an expense in the same amount from the interest rate swap. Net interest payments on the bond and interest rate swaps were fixed in 2011 by forward exchange contracts based on the six-month Euribor forward curve. The interest expense of the private placement of € 100 million made in the context of the debt issuance program in 2009 was fixed by an interest rate swap of three-month Euribor plus 0.77%, which was carried in the balance sheet as a cash flow hedge. The fair value measurement of the interest rate swap led to a fair value decline of € 3.7 million (2010: € 1.1 million). This amount was recognized in equity at 100% effectiveness. In 2011, no ineffectiveness for hedging transactions was recognized in income.