[56] Derivative financial instruments Audited

Merck uses derivative financial instruments exclusively to hedge and reduce risks from currency and interest rate positions. Merck currently uses marketable forward exchange contracts, interest rate swaps and currency options as hedging instruments. Depending on the nature of the hedged item, changes in the fair values of derivatives are recorded in the income statement either in the operating result or in the financial result. The strategy to hedge interest rate and foreign exchange rate fluctuations arising from forecast transactions and transactions already recognized in the balance sheet is set by a Merck Group risk committee, which meets on a regular basis. A planning 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 instruments were held as of the balance sheet date:

The nominal volume is the aggregate of all buy and sell amounts relating to derivative financial instruments. The fair values result from the valuation of open positions at market prices, disregarding any offsetting effects from hedged items. They correspond to the income or expenses which would result if the derivatives 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 maturities of the hedging instruments (nominal volume) are as follows as of the balance sheet date:

The forward exchange contracts and currency options entered into to reduce the exchange rate risk primarily serve to hedge intragroup 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 (€ 3,219.9 million; 2012: € 4,409.6 million), the Swiss franc (€ 603.4 million; 2012: € 528.1 million), the Japanese yen (€ 465.2 million; 2012: € 458.4 million), the British pound (€ 347.3 million; 2012: € 349.1 million) and the Taiwan dollar (€ 215.3 million; 2012: € 388.4 million) versus the euro.

Currency derivatives for which hedge accounting is not applied serve mainly to hedge currency risk from intragroup financing as well as receivables and payables denominated in foreign currency.

Forecast transactions are only hedged if the occurrence can be assumed to be highly probable. The nominal volume of hedged forecast transactions amounted to € 1,868.2 million (2012: € 2,411.6 million) as of the balance sheet date and related to both the hedging of forecast transactions in non-functional currency as well as hedging of variable interest payments for planned refinancing transactions. Moreover, intragroup monetary deposits in foreign currency in the amount of € 1,954.0 million (2012: € 2,732.1 million), intragroup borrowings in foreign currency amounting to € 151.4 million (2012: € 555.3 million) as well as a variable interest private placement with a nominal volume of € 100.0 million were also hedged. These hedging relationships represented cash flow hedges.

Overall, income of € 125.5 million (2012: € 3.6 million) from the fair value measurement of derivatives designated as cash flows hedges was recognized in equity in 2013. € 26.5 million was transferred from equity and recognized as income (2012: € 78.4 million recognized as expense). In 2013, no ineffectiveness resulted from hedge accounting.

The hedging of forecast transactions in non-functional currency related primarily to sales in U.S. dollars, Taiwan dollars and Japanese yen that are expected within the next 36 months. Forward exchange contracts and currency options were used as hedging instruments.

For the planned refinancing of the bond maturing in 2015, we entered into forward starter interest rate swap contracts with a nominal volume of € 550.0 million to hedge the interest rate level. The fair value was recognized in equity at 100% effectiveness.