Press Metal Aluminium Holdings Berhad SECTION 6 • FINANCIAL STATEMENTS 318 Notes to the Financial Statements 28. FINANCIAL INSTRUMENTS (CONT’D) 28.7 Hedging activities 28.7.1 Currency risk – Transactions in foreign currency The Group is exposed to transactional foreign currency risk to the extent that there is a mismatch between the currency in which sales are denominated and the respective functional currencies of the Group. The functional currencies of Group entities are primarily the Malaysian Ringgit (“MYR”). The currency in which these sales transactions are primarily denominated is U.S. Dollars (“USD”). The Group’s risk management policy is to hedge up to 30% of its estimated foreign currency exposure in respect of forecast sales collection over the following 12 to 120 months at any point in time. The Group purchases forward foreign exchange contracts and borrows in USD to hedge foreign sales transactions. The Group designates the forward foreign exchange contracts and foreign currency loans and borrowings in their entirety to hedge its currency risk and applies a hedge ratio of 1:1. Some of these contracts have a maturity of more than 5 years from the reporting date while the term of the foreign currency loans and borrowings ranges from 4 to 5 years. The Group determines the critical terms of the forward exchange contracts and foreign currency loans and borrowings to align with the hedged items. The Group and the Company also entered into cross currency swaps to swap their RM denominated loan to USD. The swap was performed to manage the Group’s exposure to USD and RM within the Group’s policy. The Group determines the existence of an economic relationship between the hedging instrument and hedged item based on the currency, amount and timing of their respective cash flows. The Group assesses whether the derivatives and foreign currency loans and borrowings designated in each hedging relationship are expected to be and have been effective in offsetting changes in cash flows of the hedged item. In these hedge relationships, the main sources of ineffectiveness are: • the effect of the counterparty and the Group’s own credit risk on the fair value of the forward foreign exchange contracts, which is not reflected in the change in the fair value of the hedged cash flows attributable to the change in exchange rates; and • changes in the timing of the hedged transactions. 28.7.2 Commodity price risk The Group is exposed to commodity price risk due to fluctuations in aluminium prices. The Group’s aluminium products are generally priced with reference to the LME aluminium rates. The Group adopts a policy of ensuring that up to 65% of its commodity price risk exposure is at a fixed rate. This is achieved by entering into commodity swaps and options as hedges of the variability in cash flows attributable to movements in commodity prices. The Group adjusts its hedge ratio for each commodity contract entered to minimise the potential ineffectiveness arising from such contracts. The Group determines the existence of an economic relationship between the hedging instrument and hedged item based on the reference commodity prices, tenors, maturities and the notional or par amounts. The Group assesses whether the derivatives designated in each hedging relationship are expected to be and have been effective in offsetting changes in cash flows of the hedged item. In these hedge relationships, the main sources of ineffectiveness are: • the differences in grades of aluminium produced by the Group and those provided in derivative contracts by financial institutions for the Group to enter into; and • changes in the timing of the hedged transactions.
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