31. Risk management

General information on financial risk

As a result of its businesses and the global nature of opera-tions, Daimler is exposed to market risks from changes in foreign^currency exchange rates, interest rates and equity prices, while commodity price risks arise from procurement. In addition, the Group is exposed to credit risks mainly from its lease and financing activities and from trade receivables. With regard to the lease and financing activities credit risks arise from operating lease contracts, finance lease contracts and financing contracts. Furthermore, the Group is exposed to liquidity risks relating to its credit and market risks or a deterioration of its operating business or financial market disturbances. If these financial risks materialize, they could adversely affect Daimler’s financial position, cash flows and profitability.

Daimler has established guidelines for risk controlling procedures and for the use of financial instruments, including a clear segregation of duties with regard to operating financial activities, settlement, accounting and the respective controlling. The guidelines upon which the Group’s risk management processes are based are designed to identify and analyze these risks throughout the Group, to set appropriate risk limits and controls and to monitor the risks by means of reliable and up-to-date administrative and information systems. The guidelines and systems are regularly reviewed and adjusted to changes in markets and products.

The Group manages and monitors these risks primarily through its operating and financing activities and, if required, through the use of derivative financial instruments. Daimler does not use derivative financial instruments for purposes other than risk management. Without these derivative financial instruments, the Group would be exposed to higher financial risks (additional information on financial instruments and especially on the nominal values of the derivative financial instruments used is included in Note 30). Daimler regularly evaluates its financial risks with due consideration of changes in key economic indicators and up-to-date market information.

Any market sensitive instruments, including equity and debt securities, that the funds hold to finance pension and other post-employment benefit obligations are not included in this quantitative and qualitative analysis. Please refer to Note 22 for additional information regarding Daimler’s pension plans and funds. 

Credit risk

Credit risk is the risk of economic loss arising from a counterparty’s failure to repay or service debt according to the contractual terms. Credit risk encompasses both the direct risk of default and the risk of a deterioration of creditworthiness as well as concentration risks.

The maximum risk positions of financial assets which generally are subject to credit risk are equal to their carrying amounts and are shown in the following table:

	See also Note	Maximum risk position 2010	Maximum risk position 2009
In millions of euros
Liquid assets		12,999	16,142
Receivables from financial services	14	41,030	38,478
Trade receivables	19	7,192	5,285
Derivative financial instruments used in hedge accounting (assets only)	16	816	1,074
Derivative financial instruments not used in hedge accounting (assets only)	16	731	1,218
Loan commitments	29	1,910	1,587
Other receivables and financial assets	16	1,695	1,759

Liquid assets. Liquid assets consist of cash and cash equivalents and marketable debt securities classified as available for sale. With the investment of liquid assets, the banks and issuers of securities are selected very carefully and diversified in accordance with a limit system. In connection with the financial market crisis, the limit system was adjusted and the Group reduced most of the limits. The limits and their utilizations are reassessed continuously. In this assessment Daimler also considers the credit risk assessment of its counterparties by the capital markets. In line with the Group’s risk policy, most liquid assets are held in investments with an external rating of “A” or better.

Receivables from financial services. Daimler’s financing and leasing activities are primarily focused on supporting the sale of the automotive products of the Group. As a consequence of these activities, the Group is exposed to credit risk, which is monitored and managed based on defined standards, guidelines and procedures. Daimler Financial Services manages its credit risk irrespective of whether it is related to an operating lease or a finance lease contract. For this reason, statements concerning the credit risk of Daimler Financial Services refer to the entire leasing business, unless specified otherwise.

The exposure to credit risk from financing and lease activities is monitored based on the portfolio subject to credit risk. The portfolio subject to credit risk is an internal control quantity that consists of receivables from financial services, the portion of the operating lease portfolio that is subject to credit risk and the volumes from dealer inventory financing. Receivables from financial services comprise claims arising from finance lease contracts and repayment claims from financing loans. The operating lease portfolio is reported under “equipment on operating leases” in the Group’s consolidated financial statements.

In addition, the Daimler Financial Services segment is exposed to credit risk from irrevocable loan commitments to retailers and end customers. At December 31, 2010, irrevocable loan commitments of Daimler Financial Services amounted to €1,722 million, of which €1,436 million had a maturity of less than one year, €262 million had maturities between 2 and 3 years, and €24 million had maturities between 3 and 4 years. In 2009, irrevo-cable loan commitments of Daimler Financial Services amounted to €1,503 million, of which €651 million had a maturity of less than one year, and €852 million had maturities between 2 and 3 years.

The Daimler Financial Services segment has guidelines at a global as well as at a local level which set the framework for effective risk management. In particular, these rules deal with minimum requirements for all risk-relevant credit processes, the evaluation of customer quality, requests for collateral as well as the treatment of unsecured loans and non-performing claims. The limitation of concentration risks is implemented primarily by global limits, which refer to single customer exposures. As of December 31, 2010, exposure to the top 15 customers did not exceed 4.2% (2009: 4.5%) of the total portfolio.

With respect to its financing and lease activities, the Group takes collateral for customer transactions. The value of collateral generally depends on the amount of the financed assets. Usually, the financed vehicles serve as collateral, secured by certificate of ownership. Furthermore, Daimler Financial Services mitigates the credit risk from financing and lease activities, for example through advance payments from customers.

Scoring systems are applied for the assessment of the default risk of retail and small business customers. Corporate customers are evaluated using internal rating instruments and external credit bureau data if available.

The scoring and rating results as well as the availability of security and other risk mitigation instruments, such as pre-payments, guarantees and, to a lower extent, residual debt insurances, are essential elements for credit decisions.

Significant financing loans and finance leases to corporate customers are evaluated individually for impairment. An individual loan or finance lease is considered impaired when there is objective evidence that the Group will be unable to collect all amounts due as specified by the contractual terms. Examples of objective evidence that loans or finance lease receivables are impaired include the following factors: significant financial
difficulty of the borrower, the probability that the borrower falls bankrupt or become delinquent or defaults on its installment payments, and restructured or renegotiated contracts to avoid delinquency.

The vast majority of loans and finance lease receivables related to retail or small business customers are grouped into homogeneous pools and collectively assessed for impairment. Objective evidence that loans and finance lease receivables are impaired includes, for example, adverse changes in the payment status of borrowers included in the pool and an unfavorable change in the economic conditions affecting the portfolio with similar risk characteristics.

If single loans and lease receivables are identified to be individually impaired, procedures are initiated to take possession of the asset financed or leased or, alternatively, to renegotiate the impaired contract. Restructuring policies and practices are based on the indicators or criteria which, in the judgment of local management, indicate that repayment will probably continue and that the total proceeds expected to be derived from the
 renegotiated contract exceed the expected proceeds to be derived from repossession and remarketing. For the carrying amounts of the receivables relating to renegotiated loans that would otherwise be past due or impaired, please refer to Note 14.

Further details on receivables from financial services and the balance of the recorded impairments are also provided in Note 14.

Trade receivables. Trade receivables are mostly receivables from worldwide sales activities of vehicles and spare parts. The credit risk from trade receivables encompasses the default risk of customers, e.g. dealers and general distribution companies, other corporate and private customers. Daimler manages its credit risk from trade receivables on the basis of internal guidelines.

A significant part of the trade receivables from each country’s domestic business is secured by various country-specific types of collateral. These types include, for instance, conditional sales, guarantees and sureties as well as mortgages and cash deposits. In addition, Group companies guard against credit risk via credit assessments.

For trade receivables from export business, Daimler also evaluates each general distribution company’s creditworthiness by means of an internal rating process and its country risk. In this context, the year-end financial statements and other relevant information on the general distribution companies such as the payment history are used and assessed.

Depending on the creditworthiness of the general distribution companies, Daimler usually establishes credit limits and limits credit risks with the following types of collateral:

• credit insurances,
• first-class bank guarantees and
• letters of credit.

These procedures are defined in the export credit guideline, which has Group-wide validity.

Appropriate provisions are recognized for the risks inherent in trade receivables. For this purpose, all receivables are regularly reviewed and impairments are recognized if there is any objective indication of non-performance or other contractual violations. In general, material individual receivables and receivables whose realizability is jeopardized are assessed individually. Taking country-specific risks and any collateral into consideration, the other receivables are grouped by similarity of contract and tested for impairment collectively.

Further information on trade receivables and the status of impairments recognized is provided in Note 19.

Derivative financial instruments. The Group does not use derivative financial instruments for purposes other than risk management. Daimler manages the credit risk exposure in connection with derivative financial instruments through a limit system, which is based on the review of each counterparty’s financial strength. This system limits and diversifies the credit risk. As a result, Daimler is exposed to credit risk only to a
 low extent with respect to its derivative financial instruments. According to the Group’s risk policy, most derivatives are contracted with counterparties who have an external rating of “A” or better.

Other receivables and financial assets. With respect to other receivables and financial assets in 2009 and 2010, Daimler is exposed to credit risk only to a low extent.

Liquidity risk

Liquidity risk comprises the risk that a company cannot meet its financial obligations in full.

Daimler manages its liquidity by holding adequate volumes of liquid assets and maintaining syndicated credit facilities in addition to the cash inflows generated by its operating business. The liquid assets comprise cash and cash equivalents as well as debt instruments classified as held for sale. The Group can dispose of these liquid assets at short notice. In general, Daimler makes use of a broad spectrum of financial instruments to cover its funding requirements. Depending on funding requirements and market conditions, Daimler issues commercial paper, bonds and financial instruments secured by receivables in various currencies. Credit lines are also used to cover financing requirements. In addition, customer deposits at Mercedes-Benz Bank have been used as a further source of refinancing. The funds raised are primarily used to finance the cash needs of the lease and financing business as well as working capital and capital expenditure requirements. According to internal guidelines, the refunding of the lease and financing business is generally carried out with matching maturities of cash flows. 

At year-end 2010 liquidity amounted to €13.0 billion (2009: €16.1 billion). In light of the financial and economic crisis and the resulting risks, the Group deliberately increased its liquidity in 2009.

At year-end 2010 the Group had short-term and long-term credit lines totaling €24.0 billion, of which €9.4 billion was not utilized. These credit lines include a syndicated €7.0 billion credit facility of Daimler AG with 5 year tenor which was signed in October 2010. This syndicated facility serves as a back-up for commercial paper drawings and provides funds for general corporate purposes. At the end of 2010, this facility was unused. 

From an operating point of view, the management of the Group’s liquidity exposures is centralized by a daily cash pooling process. This process enables Daimler to manage its liquidity surplus and liquidity requirements according to the actual needs of the Group and each subsidiary. The Group’s short-term and mid-term liquidity management takes into account the maturities of financial assets and financial liabilities and estimates of cash flows from the operating business.

Information on the Group’s financing liabilities is also provided in Note 24 to the consolidated financial statements.

The following table provides an insight into how the liquidity situation of the Group is affected by the cash flows from financial liabilities and financial guarantees as of December 31, 2010.

Liquidity runoff 1
	Total	2011	2012	2013	2014	2015	= 2016
In millions of euros
Financing liabilities 2	60,413	27,885	12,238	7,827	5,498	1,648	5,317
Derivative financial instruments 3	2,631	1,627	693	195	109	4	3
Trade payables 4	7,657	7,655	2	–	–	–	–
Other financial liabilities excluding derivatives	8,501	7,496	340	332	113	60	160
Irrevocable loan commitments of the Daimler Financial Services segment and of Daimler AG 5	1,910	1,624	102	160	24	–	–
Financial guarantees 6	1,140	1,140	–	–	–	–	–
Total	82,252	47,427	13,375	8,514	5,744	1,712	5,480

¹ The values were calculated as follows:
(a) If the counterparty can request payment at different dates, the liability is included on the basis of the earliest date on which Daimler can be required to pay.
The customer deposits of Mercedes-Benz Bank are considered in this analysis to mature within the first year.
(b) The cash flows of floating interest financial instruments are estimated on the basis of forward rates.
² The stated cash flows of financing liabilities consist of their undiscounted principal and interest payments.
³ The undiscounted sum of the net cash outflows of the derivative financial instruments are shown for the respective year. For single time bands, this may also include negative cash flows from derivatives with an overall positive fair value.
⁴The cash outflows of trade payables are undiscounted.
⁵The maximum available amounts are stated.
⁶ The maximum potential obligations under the issued guarantees is stated. It is assumed that the guarantees are called within the first year.

Finance market risks

The global nature of its businesses exposes Daimler to significant market risks resulting from fluctuations in foreign currency exchange rates and interest rates. In addition, the Group is exposed to market risks in terms of commodity price risk associated with its business operations, which the Group hedges partially through derivative financial instruments. The Group is also exposed to equity price risk. If these market risks materialize, they will adversely affect the Group’s financial position, cash flows and profitability.

Daimler manages market risks to minimize the impact of fluctuations in foreign exchange rates, interest rates and commodity prices on the results of the Group and its segments. The Group calculates its overall exposure to these market risks to provide the basis for hedging decisions, which include the selection of hedging instruments and the determination of hedging volumes and the corresponding periods. Decisions regarding the management of market risks resulting from fluctuations in foreign exchange rates, interest rates (asset-/liability management) and commodity prices are regularly made by the relevant Daimler risk management committees.

As part of its risk management system, Daimler employs value at risk analyses as recommended by the Bank for International Settlements. In performing these analyses, Daimler quantifies its market risk exposure to changes in foreign currency exchange rates and interest rates on a continuous basis by predicting the maximum loss over a target time horizon (holding period) and confidence level.

The value at risk calculations employed:

• express potential losses in fair values, and
• assume a 99% confidence level and a holding period of five days.

Daimler calculates the value at risk for exchange rate and interest rate risk according to the variance-covariance approach. The value at risk calculation method for commodity hedging instruments is based on the Monte Carlo simulation.

When calculating the value at risk by using the variance-covariance approach, Daimler first computes the current fair value of the Group’s financial instruments portfolio. Then the sensitivity of the portfolio value to changes in the relevant market risk factors, such as particular foreign currency exchange rates or interest rates of specific maturities, is quantified. Based on expected volatilities and correlations of these market risk
 factors which are obtained from the RiskMetrics™ dataset, a statistical distribution of potential changes in the portfolio value at the end of the holding period is computed. The loss which is reached or exceeded with a probability of only 1% can be deduced from this calculation and represents the value at risk.

The Monte Carlo simulation uses random numbers to generate possible changes in market risk factors over the holding period. The changes in market risk factors indicate a possible change in the portfolio value. Running multiple repetitions of this simulation leads to a distribution of portfolio value changes. 

The value at risk can be determined based on this distribution as the portfolio value loss which is reached or exceeded with a probability of 1%.

In accordance with the risk management standards of the international banking industry, Daimler maintains its financial controlling system independent of Corporate Treasury and with a separate reporting line.

Exchange rate risk. Transaction risk and currency risk management. The global nature of Daimler’s businesses exposes cash flows and earnings to risks arising from fluctuations in exchange rates. These risks primarily relate to fluctuations between the US dollar and the euro.

In the operating vehicle businesses, the Group’s exchange rate risk primarily arises when revenue is generated in a currency that is different from the currency in which the costs of generating the revenue are incurred (so-called transaction risk). When the revenue is converted into the currency in which the costs are incurred, it may be inadequate to cover the costs if the value of the currency in which the revenue is generated declined in the
 interim relative to the value of the currency in which the costs were incurred. This risk exposure primarily affects the Mercedes-Benz Cars segment, which generates a major portion of its revenue in foreign currencies and incurs manufacturing costs primarily in euros. The Daimler Trucks segment is also subject to transaction risk, but to a lesser extent because of its global production network. The Mercedes-Benz Vans and Daimler Buses segments are also directly exposed to transaction risk, but only to a minor degree compared to the Mercedes-Benz Cars and Daimler Trucks segments. In addition, through its proportionate share in the results of its equity investment in EADS, the Group is indirectly exposed to transaction risk.

Cash inflows and outflows of the business segments are offset if they are denominated in the same currency. This means that the exchange rate risk resulting from revenue generated in a particular currency can be offset by costs in the same currency, even if the revenue arises from a transaction independent of that in which the costs are incurred. As a result, only the net exposure is subject to transaction risk. In addition, natural hedging opportunities exist to the extent that currency exposures of the operating businesses of individual segments offset each other at Group level, thereby reducing overall currency exposure. These natural hedges eliminate the need for hedging to the extent of the matched exposures. To provide an additional natural hedge against any remaining transaction risk exposure, Daimler generally strives to increase cash outflows in the same currencies in which the Group has a net excess inflow.

In order to mitigate the impact of currency exchange rate fluctuations for the operating business (future transactions), Daimler continually assesses its exposure to exchange rate risks and hedges a portion of those risks by using derivative financial instruments. These hedging transactions mainly represent macro hedges. Daimler’s Foreign Exchange Committee (FXCo) manages the Group’s exchange rate risk and its hedging transactions through currency derivatives. The FXCo consists of the Chief Financial Officer, the head of the Investor Relations & Treasury, and the heads of the Controlling departments of the relevant segments as well as Corporate Controlling. The Corporate Treasury department assesses foreign currency exposures and carries out the FXCo’s decisions concerning foreign currency hedging through transactions with international financial institutions. Risk Controlling regularly informs the Board of Management of the actions taken by Corporate Treasury based on the FXCo’s decisions.

The Group’s targeted hedge ratios for forecasted operating cash flows in foreign currency are indicated by a reference model. On the one hand, the hedging horizon is naturally limited by uncertainty related to cash flows that lie far in the future, and, on the other hand, it may be limited by the fact that appropriate currency contracts are not available. This reference model aims to protect the Group from unfavorable movements in exchange rates while preserving some flexibility to participate simultaneously in favorable developments. Based on this reference model and depending on the market outlook, the FXCo determines the hedging horizon, which usually varies from one to three years, as well as the average hedge ratios. Reflecting the character of the underlying risks, the hedge ratios decrease with increasing maturities. At year-end 2010, the centralized foreign exchange management showed an unhedged position in the automotive business for the underlying forecasted cash flows in US dollars in calendar year 2011 of 28%. The corresponding figure at year-end 2009 for calendar year 2010 was 30%. The lower unhedged position compared to last year contributes to a lower exposure of cash flows to currency risk with respect to the US dollar.

The hedged position of the operating vehicle businesses is determined by the amount of derivative currency contracts held. The derivative financial instruments used to cover foreign currency exposure are primarily forward foreign exchange contracts and currency options. Daimler’s guidelines call for a mixture of these instruments depending on the view of market conditions. Value at risk is used to measure the exchange rate risk inherent in these derivative financial instruments.

The following table shows the period-end, high, low and average value at risk figures for the 2010 and 2009 portfolio of the derivative financial instruments, which were entered into primarily in connection with the operative vehicle businesses. The average exposure has been computed on an end-of-quarter basis. The offsetting transactions underlying the derivative financial instruments are not included in the following value at risk presentation.

	2010				2009
	Period-end	High	Low	Average	Period-end	High	Low	Average
In millions of euros
Exchange rate risk (from derivative financial instruments)	558	590	346	507	177	692	165	337

The increase of the vehicle sales forecasts in the course of 2010 led to an increase of the foreign currency hedge volume in the operative vehicle businesses. Because the stated foreign currency value at risk refers to the portfolio of the derivative foreign currency hedging contracts, the pronounced increase of the value at risk in 2010 is mainly attributable to the increase of the hedge volume.

The Group’s investments in liquid assets generally do not result in currency risk, as this is governed by internal guidelines. Transaction risks arising from payables in foreign currencies that result from the Group’s refinancing on money and capital markets are generally hedged against currency risks at the time of refinancing in accordance with Daimler’s internal guidelines. The Group uses appropriate derivative financial
 instruments (e.g. cross currency interest rate swaps) to hedge against currency risk.

Since currency risks arising from the Group’s refinancing in foreign currencies and the respective hedging transactions principally offset each other these financial instruments are not included in the above presented value at risk calculation.

Effects of currency translation. For purposes of Daimler’s consolidated financial statements, the income and expenses and the assets and liabilities of subsidiaries located outside the euro zone are converted into euros. Therefore, period-to-period changes in average exchange rates may cause translation effects that have a significant impact on, for example, revenue, segment results (earnings before interest and taxes – EBIT)
 and net profit or loss of the Group. Unlike exchange rate transaction risk, exchange rate translation risk does not necessarily affect future cash flows. The Group’s equity position reflects changes in book values due to exchange rates. Daimler does not hedge against exchange rate translation risk.

Interest rate risk. Daimler uses a variety of interest rate sensitive financial instruments to manage the liquidity and cash needs of its day-to-day operations. A substantial volume of interest rate sensitive assets and liabilities results from the leasing and sales financing business operated by the Daimler Financial Services segment. The Daimler Financial Services companies enter into transactions with customers that pri-marily result in fixed-rate receivables. Daimler’s general policy is to match funding in terms of maturities and interest rates, where economically feasible. However, for a limited portion of the receivables portfolio in selected and developed markets, the Group does not match funding in terms of maturities in order to take advantage of market opportunities. As a result, Daimler is exposed to risks due to changes in interest rates. In this regard,
the Group does not create liquidity risks.

An asset/liability committee consisting of members of the Daimler Financial Services segment, the Corporate Treasury department and the Corporate Controlling department manages the interest rate risk relating to Daimler’s leasing and financing activities by setting targets for the interest rate risk position. The Treasury Risk Management department and the local Daimler Financial Services companies are jointly responsible for achieving these targets. As a separate function, the Daimler Financial Services Risk Management department monitors target achievement on a monthly basis. In order to achieve the targeted interest rate risk positions in terms of maturities and interest rate fixing periods, Daimler generally uses derivative financial instruments, such as interest rate swaps, forward rate agreements, swaptions and caps and floors. Daimler assesses its interest rate risk position by comparing assets and liabilities for corresponding maturities, including the impact of the relevant derivative financial instruments. The interest rate risk hedges represent primarily micro hedges.

Derivative financial instruments are also used in conjunction with the refinancing related to the industrial business. Daimler coordinates the funding activities of the industrial and financial services businesses at the Group level. 

The following table shows the period-end, high, low and average value at risk figures for the 2010 and 2009 portfolio of interest rate sensitive financial instruments and derivative financial instruments of the Group, including the derivative financial instruments of the leasing and sales financing business. In this respect, the table shows the interest rate risk regarding the unhedged position of interest rate sensitive financial instruments. The average values have been computed on an end-of-quarter basis.

	2010				2009
	Period-end	High	Low	Average	Period-end	High	Low	Average
In millions of euros
Interest rate risk	49	52	33	45	49	49	33	41

The value at risk of the interest rate sensitive financial instruments in 2010 is almost unchanged in comparison to 2009.

Commodity price risk. Daimler is exposed to the risk of changes in raw material prices in connection with procuring raw materials and manufacturing supplies used in production. Some of the raw material price risk, primarily relating to forecasted procuring of certain metals, is mitigated with the use of derivative financial instruments. These hedges represent macro hedges.

For precious metals, central commodity management shows an unhedged position of 26% of the forecasted commodity purchas-es at year-end for calendar year 2011. The corresponding figure at year-end 2009 was 27% for calendar year 2010.

The following table shows the period-end, high, low and average value at risk figures for the 2010 and 2009 portfolio of derivative financial instruments used to hedge raw material price risk. The average exposure has been computed on an end-of-quarter basis. The offsetting transactions underlying the derivative financial instruments are not included in the following value at risk presentation.

	2010				2009
	Period-end	High	Low	Average	Period-end	High	Low	Average
In millions of euros
Commodity price risk (from derivative financial instruments)	52	52	27	38	24	35	21	27

The increase of the vehicle sales forecasts in the course of 2010 led to an increase of the commodity hedge volume. Because the stated commodity value at risk refers to the portfolio of the derivative commodity hedging contracts, the increase of the value at risk in 2010 is primarily attributable to the increase of the hedge volume. In addition, the increased commodity prices and commodity price volatilities contributed to the increase
of the commodity value at risk in 2010.

Equity price risk. Daimler holds investments in marketable equity securities. In line with international banking standards, the Group does not include these investments which it classifies as long-term investments in its equity price risk assessment.