NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS for the period ended 28 July 2018 E. RISK MANAGEMENT This section provides information relating to the Group's exposure to various financial risks, how they could affect the Group's financial position and performance and how these risks are managed. E1 FINANCIAL RISK MANAGEMENT The Group's activities expose it to a variety of financial risks: market risk (including currency risk, cash flow and fair value interest rate risk), credit risk and liquidity risk. The Group's overall risk management program focuses on the unpredictability of financial markets and seeks to minimise potential adverse effects on the financial performance of the Group. The Group uses derivative financial instruments such as foreign exchange contracts and interest rate swaps to hedge certain risk exposures. Derivatives are exclusively used for hedging purposes, i.e. not as trading or other speculative instruments. The Group uses different methods to measure different types of risk to which it is exposed. These methods include sensitivity analysis in the case of interest rate and foreign exchange risk, and an aging analysis for credit risk. Risk management is carried out by the Company under policies approved by the Board of Directors. The Company identifies, evaluates and hedges financial risks. The Board provides written principles for overall risk management, as well as policies covering specific areas, such as foreign exchange risk, interest rate risk, and use of financial instruments and non-derivative financial instruments. (a) Market risk (i) Foreign exchange risk Foreign exchange risk arises when future commercial transactions and recognised assets and liabilities are denominated in a currency that is not the entity’s functional currency. The Group sources inventory purchases overseas and is exposed to foreign exchange risk, particularly in relation to currency exposures to the US dollar. To minimise the effects of a volatile and unpredictable exchange rate, Group policy is to enter into forward exchange contracts in relation to the Group’s overseas purchases for any 18-month period. The actual level of cover taken fluctuates depending on the period until settlement of the foreign currency transaction, within the Board approved hedging policy. This policy allows cover to be taken on a sliding scale between 0 – 100% depending on the period to maturity (up to 18 months). The Group's exposure to foreign currency risk at the end of the reporting period, expressed in Australian dollars, was as follows: 2018 2017 USD EURO USD EURO $'000 $'000 $'000 $'000 Trade payables 23,765 98 16,770 540 Forward exchange contracts 166,659 6,851 163,851 7,773 Group sensitivity The Group applies a prudent cash flow hedging policy approach whereby all forward exchange contracts in relation to the Group's overseas purchases are designated as cash flow hedges at inception. Subsequent testing of effectiveness ensures that all effective hedge movements flow through the cash flow hedge reserve within equity. Consistent with this approach, the sensitivity for movements in foreign exchange rates for US dollar and Euro denominated financial instruments held at 28 July 2018, as detailed in the above table, will flow through equity and will therefore have minimal impact on profit. Other components of equity would have been $14.7 million lower/$17.9 million higher (2017: $12.1 million lower/$14.8 million higher) had the Australian dollar strengthened/weakened by 10% against the US dollar and Euro, arising from foreign exchange contracts designated as cash flow hedges. The Group's exposure to other foreign exchange movements is not material. These sensitivities were calculated based on the Group's period end spot rate for the applicable reporting period. (ii) Cash flow and fair value interest rate risk The Group is exposed to interest rate risk as it borrows funds at floating interest rates. Borrowings issued at floating rates expose the Group to cash flow interest rate risk. The risk is managed by the use of floating to fixed interest rate swap contracts and the Group policy is to fix the rates between 0 and 50% of its average gross debt. Interest rate swaps have the economic effect of converting borrowings from floating rates to fixed rates. Generally, the Group raises long term borrowings at floating rates and swaps them into fixed rates. Under the interest rate swaps, the Group agrees with other parties to exchange, at specified intervals (mainly quarterly), the difference between fixed rate and floating rate interest amounts calculated by reference to the agreed notional principal amounts. As at the end of the reporting period, the Group had the following variable rate borrowings and interest rate swap contracts outstanding: 2018 2017 eighte eighted average interest average rate Balance interest rate Balance % $'000 % $'000 Bank loans - variable 3.2% 150,000 3.0% 145,000 Interest rate swaps (notional principal amount) 3.3% (100,000) 5.2% (100,000) Net exposure to cash flow interest rate risk 50,000 45,000 The weighted average interest rates noted above for both borrowings and swaps are inclusive of margins applicable to the underlying variable rate borrowings. An analysis by maturities is provided in section (c) below. 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