Pearson

Annual Report and Accounts 2010

Notes to the consolidated financial statements

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16. Derivative financial instruments

The Group’s approach to the management of financial risks is set out in note 19. The Group’s outstanding derivative financial instruments are as follows:

All figures in £ millions 2010 2009
Gross notional amounts Assets Liabilities Gross notional amounts Assets Liabilities
Interest rate derivatives – in a fair value hedge relationship 1,327 112 1,103 70
Interest rate derivatives – not in a hedge relationship 256 8 486 13 (7)
Cross currency rate derivatives – in a net investment hedge relationship 220 20 (6) 220 29 (2)
Total 1,803 140 (6) 1,809 112 (9)
Analysed as expiring:
In less than one year 319 6 238 (7)
Later than one year and not later than five years 749 74 (6) 844 60 (2)
Later than five years 735 60 727 52
Total 1,803 140 (6) 1,809 112 (9)

The carrying value of the above derivative financial instruments equals their fair value. Fair values are determined by using market data and the use of established estimation techniques such as discounted cash flow and option valuation models.

At the end of 2010, the currency split of the mark-to-market values of rate derivatives, including the exchange of principal on cross currency rate derivatives, was US dollar £(97)m, sterling £259m and South African rand £(28)m (2009: US dollar £(127)m, sterling £252m and South African rand £(22)m).

The fixed interest rates on outstanding rate derivative contracts at the end of 2010 range from 3.65% to 9.28% (2009: 3.65% to 9.28%) and the floating rates are based on LIBOR in US dollar and sterling.

The Group’s portfolio of rate derivatives is diversified by maturity, counterparty and type. Natural offsets between transactions within the portfolio and the designation of certain derivatives as hedges significantly reduce the risk of income statement volatility. The sensitivity of the portfolio to changes in market rates is set out in note 19.

Counterparty exposure from all derivatives is managed, together with that from deposits and bank account balances, within credit limits that reflect published credit ratings and by reference to other market measures (e.g. market prices for credit default swaps) to ensure that there is no significant risk to any one counterparty. No single derivative transaction had a market value (positive or negative) at the balance sheet date that exceeded 3% of the Group’s consolidated total equity.

In accordance with IAS 39 ‘Financial Instruments: Recognition and Measurement’ the Group has reviewed all of its material contracts for embedded derivatives that are required to be separately accounted for if they do not meet certain requirements, and has concluded that there are no material embedded derivatives.