[60] Management of financial risks Audited

Market fluctuations with respect to foreign exchange and interest rates represent significant profit and cash flow risks for Merck. Merck aggregates these Group-wide risks and steers them also by using derivative financial instruments. Merck uses scenario analyses to estimate existing risks of foreign exchange and interest rate fluctuations as well as credit defaults. Merck is not subject to any material risk cluster from financial transactions. The Risk Report included in the Management Report provides further information on the management of financial risks.

Foreign exchange risks

Owing to its international business focus, Merck is exposed to foreign exchange-related transaction risks within the scope of both ordinary business and financing activities. Different strategies are used to limit or eliminate these risks. Foreign exchange risks from recognized transactions are eliminated as far as possible through the use of forward exchange contracts. Foreign exchange risks arising from planned transactions are analyzed regularly and reduced if necessary through forward exchange contracts or currency options applying hedge accounting.

The following table presents the net foreign exchange risk from expected and recognized transactions in 2012 in the key currencies and exchange rate fluctuations versus the euro:

Further significant foreign exchange risks also resulted from transactions booked in Taiwan dollars, Hong Kong dollars as well as Venezuelan bolivars subject to exchange rate movements versus the U.S. dollar. The changes in foreign exchange positions as a result of a 10% appreciation in the value of the U.S. dollar would be € 0.0 million (2011: € 0.0 million) for the Taiwan dollar position after hedging, € 4.1 million (2011: € 2.5 million) for the Venezuelan bolivar position, and € –0.9 million (2011: € 1.6 million) for the Hong Kong dollar position, and would be fully recognized in income. Moreover, derivatives existed to hedge expected cash flows beyond the year 2013. A 10% increase in the value of the euro over the Japanese yen, the Taiwan dollar and the U.S. dollar would have changed equity by € 14.5 million, € 9.8 million and € 65.4 million, respectively. In 2011, owing to hedging of expected cash flows beyond the year 2012, a 10% increase in the value of the euro over the Japanese yen, the Taiwan dollar and the U.S. dollar would have caused a change in equity of € 21.5 million, € 0.0 million and € 60.5 million, respectively.

The corresponding net foreign exchange rate risk from expected and recognized transactions for 2011 was as follows:

In addition to the previously described transaction risks, the Merck Group is also exposed to currency translation risks since many Merck companies are located outside the eurozone. The financial statements of these companies are translated into euros. Exchange differences in the assets and liabilities of these companies resulting from currency translation are recognized in equity.

Interest rate risks

Interest rate risks related mainly to financial liabilities of € 4,453.5 million (2011: € 5,539.3 million) and monetary deposits of € 2,624.7 million (2011: € 2,115.2 million). The aim is to optimize the interest result and to minimize interest rate risks. If necessary, derivative financial instruments are used to change variable interest payments into fixed interest payments.

Relative to net interest liabilities on the balance sheet date, owing to the large proportion of fixed-interest financial instruments, a parallel shift in interest rates by +100 or –100 basis points would not have a material effect. Assuming a refinancing as well as reinvestment of the same amount for the transactions expiring in 2013, a parallel shift in the interest rate curve by + 100 basis points would lead to income of € 12.5 million (2011: € 10.3 million). A parallel shift in interest rates by –100 basis points would lead to an expense of € 9.6 million (2011: € 9.7 million). This corresponds to a change in interest income of € 14.1 million (2011: € 15.7 million) or € –11.2 million (2011: € –14.8 million) on financial assets and additional interest expense of € 1.6 million (2011: € 5.4 million) or a decline in interest expense of € 1.6 million (2011: € 5.1 million) on financial liabilities. The resulting change in assets and derivative financial instruments measured at fair value would increase equity by € 31.6 million (2011: increase by € 51.3 million) or lower it by € 41.5 million (2011: lowered by € 52.9 million). The scenario calculations here assumed that the interest rate cannot fall below 0%.

Share price risks

The shares in publicly listed companies amounting to € 6.9 million (2011: € 8.7 million) are generally exposed to a market value risk. A 10% change in the value of the stock market would impact equity by € 0.7 million (2011: € 0.9 million). This change in value would be recognized in income at the time of disposal.

Liquidity risks

The liquidity risk, meaning the risk that Merck cannot meet its payment obligations resulting from financial liabilities, is limited by establishing the required financial flexibility and by effective cash management. Apart from liquid assets of € 2,527.6 million (2011: € 2,054.9 million), Merck had at its disposal a multi-currency revolving credit line of € 2 billion to be used for business purposes with a remaining term of two years as well as bilateral credit facilities of € 338.2 million (2011: € 389.8 million). There were no indications that the availability of credit lines already extended were restricted.

Moreover, a commercial paper program with a volume of € 2 billion and a debt issuance program set up in 2009 with a volume of € 10 billion exist. Liquidity risks are regularly monitored and reported to management. The loan agreements do not contain any financial covenants.

Trade payables amounting to € 1,288.3 million (2011: € 1,100.8 million) had a remaining term of less than one year. With respect to liabilities from operating derivatives amounting to € 15.0 million (2011: € 101.1 million), € 12.2 million (2011: € 64.5 million) was short-term. Out of other financial liabilities amounting to € 522.9 million (2011: € 532.9 million), € 520.1 million (2011: € 529.1 million) was due within one year.

The following tables present the contractually set payments such as repayments and interest on financial liabilities and derivative financial instruments with a negative fair value:

Credit risks

Merck is only subject to a relatively low credit risk, meaning the unexpected loss of payment funds or  income. On the one hand, financial contracts are only entered into with banks and industrial companies with good credit ratings and on the other hand, the broad-based business structure of the Merck Group means that there is no particularly high concentration of credit risks with respect to either customers or individual countries. The credit risk with customers is continuously monitored by analyzing the age structure of trade accounts receivable. The financial crisis has led to an increased risk of default in individual eurozone countries. Merck continuously reviews and monitors open positions vis-à-vis all trading partners in the affected countries and makes adjustments to its default risks as necessary. The theoretically maximum default risk corresponded to the book values.