Financial Statements

30. Financial instruments

The system used by the Bayer Group to manage credit risk, liquidity risk and the various types of market risks (interest-rate risk, currency risk and other price risks), together with its objectives, methods and procedures, is outlined in the Risk Report, which forms part of the Management Report.

30.1 Information on financial instruments by category

The following table shows the carrying amounts and fair values of financial assets and liabilities by category of financial instrument and a reconciliation to the corresponding line item in the balance sheet. Since the line items “Other receivables” and “Other liabilities” contain both financial instruments and non-financial assets and liabilities (such as other tax receivables or advance payments for services to be received in the future), the reconciliation is shown in the column headed “Non-financial assets/liabilities.”

Loans and receivables and liabilities carried at amortized cost also include receivables and liabilities under finance leases where Bayer is the lessor or lessee and which therefore have to be measured in accordance with IAS 17.

The fair value of receivables, loans, held-to-maturity financial investments and primary liabilities is measured as the present value of future cash inflows or outflows, discounted at a current interest rate as of the closing date and taking into account the due date of assets or remaining term of liabilities and the rating of Bayer AG. Where a market price is available, this is taken as the fair value.

Because of the short maturities of most trade accounts receivable and payable, other receivables and liabilities, and cash and cash equivalents, the net carrying amounts at the balance sheet date do not differ significantly from the fair values.

Income, expense, gains and losses on financial instruments can be assigned to the following categories:

2007
€ million	Loans and receiv- ables	Held-to- maturity invest- ments	Available- for-sale financial assets	Held for trading (deri- vatives only)	Liabilities carried at amortized cost	Total
Interest income	243	9	9	114	350	725
Interest expense	-	-	-	(107)	(1,288)	(1,395)
Income from affiliated companies	-	-	-	-	-	-
Changes in fair value	-	-	-	1	-	1
Impairment charges	(107)	-	(27)	-	-	(134)
Income from write-backs	83	-	-	-	-	83
Gains/losses from retirements	-	-	1	-	-	1
Other non-operating income and expense	12	-	(1)	-	1	12
Net result	231	9	(18)	8	(937)	(707)

2006
€ million	Loans and receiv- ables	Held-to- maturity invest- ments	Available- for-sale financial assets	Held for trading (deri- vatives only)	Liabilities carried at amortized cost	Total
Interest income	206	17	15	259	140	637
Interest expense	-	-	-	(306)	(1,030)	(1,336)
Income from affiliated companies	-	-	5	-	-	5
Changes in fair value	-	-	-	(4)	-	(4)
Impairment charges	(140)	-	(20)	-	-	(160)
Income from write-backs	102	-	-	-	-	102
Gains/losses from retirements	-	-	19	-	-	19
Other non-operating income and expense	(4)	-	-	-	(1)	(5)
Net result	164	17	19	(51)	(891)	(742)

The column headed “Held for trading” consists almost entirely of interest income and expenses relating to interest-rate and cross-currency interest-rate hedges that do not qualify for hedge accounting (see Note [13.2]).

30.2 Maturity analysis

As of the reporting date, the liquidity risk to which the Bayer Group was exposed from its financial instruments comprises obligations relating to future interest and repayment installments for financial liabilities and the liquidity risk arising from derivative financial instruments, as shown in this table.

The carrying amount of bonds includes €2,285 million (2006: €2,276 million) for the mandatory convertible bond. This includes future interest payments but not repayment installments.

30.3 Accounting for derivative financial instruments

The Bayer Group uses derivative financial instruments to mitigate the risk of changes in exchange rates, interest rates and commodity prices. Many transactions constitute economic hedges but do not qualify for hedge accounting under IAS 39 (Financial Instruments: Recognition and Measurement). Changes in the fair value of these derivative financial instruments are recognized directly in the income statement. Fair value changes from forward exchange contracts and currency options are reflected in exchange gains and losses, those from interest-rate swaps and interest-rate options in interest income and expense, and those from commodity futures and commodity options in other operating income and expenses.

The fair values of derivative financial instruments are measured by the usual methods in light of the market data available at the measurement date. Currency and commodity contracts are measured individually at their forward rates or forward prices on the balance sheet date. These depend on spot prices including time spreads. The fair values of interest-rate hedging instruments are determined by discounting future cash flows over the remaining terms of the instruments at market rates of interest. The present value of each interest-rate, currency or cross-currency interest-rate swap transaction is measured individually as of the balance sheet date. Interest income is recognized in the income statement at the date of payment or, in case of accrual, at the balance sheet date. Certain long-term commodity contracts to which fair values cannot be assigned are measured with the aid of valuation models based on internal fundamental data.

Changes in the fair values of derivative financial instruments designated as fair value hedges are recognized without any effect on the income statement along with the underlying transactions. Changes in the fair values of the effective portion of derivatives designated as cash flow hedges are initially recognized not in the income statement, but in stockholders’ equity under other comprehensive income. They are released to the income statement when the underlying transaction is realized. The effects of hedging forecasted transactions denominated in foreign currencies and of hedging planned commodity purchases are recognized in other operating income and expense at the date of realization. If a derivative is sold or ceases to qualify for hedge accounting, the amount reflected in other comprehensive income continues to be recognized in this item until the forecasted transaction is realized. If the forecasted transaction is no longer probable, the amount previously recognized in other comprehensive income is released to the income statement.

The income and expense reflected in the non-operating result pertaining to the derivatives and the underlying transactions are shown separately. Income and expense are not offset.

Fair value hedges
Fair value hedges are used to eliminate the risk of changes in fair value, especially on fixed-interest borrowings, by obtaining a variable interest rate. Essentially these fair value hedges relate to the €2 billion bond issued in 2002 and the €1.3 billion bond issued in 2005.

The ineffective portion of fair value hedges amounts to €1 million (2006: €3 million).

Cash flow hedges
Fluctuations in future cash flows from forecasted foreign currency transactions are avoided by designating cash flow hedges. Cash flow hedges are also used to partially limit exposure to fluctuations in future cash flows resulting from price changes on procurement markets. Such cash flow hedges relate to forecasted transactions or the risk of price fluctuations in procurement transactions with total notional volumes of €1,294 million and €293 million (2006: €1,761 million and €389 million), respectively.

Other comprehensive income increased by €124 million in 2007 (2006: €43 million decrease) due to positive changes in the fair values of derivatives designated as cash flow hedges. Income of €65 million (2006: expense of €11 million) was released from other comprehensive income to other operating income and expenses. Pro-rated deferred taxes of €19 million (2006: expense of €3 million), previously recognized in other comprehensive income, was transferred to deferred tax expenses. No ineffective portions of hedges had to be recognized in the income statement in 2007 (2006: €5 million).

An amount of €22 million (2006: €38 million) is expected to be reclassified from other comprehensive income to the income statement during 2008. The realization of all forecasted transactions is considered highly probable.

The market values of contracts existing at year end in the major categories were as follows:

	Dec. 31, 2006			Dec. 31, 2007
		Fair value			Fair value
€ million	Notional amount	Positive fair value	Negative fair value	Notional amount	Positive fair value	Negative fair value
Currency hedging of recorded transactions	10,305	78	(29)	5,523	136	(54)
Forward exchange contracts	8,960	40	(19)	4,572	77	(24)
of which FV hedges	0	0	0	0	0	0
of which CF hedges	-	-	-	-	-	-
Currency options	76	2	(1)	34	2	(1)
of which FV hedges	0	0	0	0	0	0
of which CF hedges	-	-	-	-	-	-
Cross-currency interest-rate swaps	1,269	36	(9)	917	57	(29)
of which FV hedges	0	0	0	0	0	0
of which CF hedges	965	33	(9)	874	57	(29)

Currency hedging of forecasted transactions	1,761	54	(4)	1,294	69	(7)
Forward exchange contracts	1,761	54	(4)	1,294	69	(7)
of which FV hedges	-	-	-	-	-	-
of which CF hedges	1,201	51	(2)	1,273	68	(7)
Currency options	0	0	0	0	0	0
of which FV hedges	-	-	-	-	-	-
of which CF hedges	0	0	0	0	0	0

Interest rate hedging of recorded transactions	11,633	110	(157)	8,703	99	(183)
Interest rate swaps	10,633	106	(156)	7,703	95	(183)
of which FV hedges	5,708	22	(145)	1,719	7	(69)
of which CF hedges	-	-	-	-	-	-
Interest rate options	1,000	4	(1)	1,000	4	0
of which FV hedges	-	-	-	-	-	-
of which CF hedges	-	-	-	-	-	-

Commodity price hedging	389	137	(225)	293	247	(219)
Forward commodity contracts	323	76	(149)	208	86	(70)
of which FV hedges	0	0	0	0	0	0
of which CF hedges	72	2	(70)	8	2	(1)
Commodity option contracts	66	61	(76)	85	161	(149)
of which FV hedges	-	-	-	-	-	-
of which CF hedges	-	-	-	-	-	-

Total	24,088	379	(415)	15,813	551	(463)
of which short-term derivative financial instruments	15,484	135	(57)	6,071	180	(79)
for currency hedging	11,101	103	(31)	5,878	142	(30)
for interest rate hedging	4,127	0	(4)	0	0	0
for commodity hedging	256	32	(22)	193	38	(49)

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