Form 20-F 2005

Even aside from the effect of competition, fluctuations in exchange rates have had a direct accounting impact on our results. We
estimate that in 2005 this accounting effect caused a 2.9% decrease in consolidated net sales and a 4% decrease in operating
income. Currency fluctuations can also have a significant impact on our balance sheet, in particular on shareholders’ equity, when
the financial statements of subsidiaries outside the euro zone are translated into euros.
Our policy is to limit our exposure to short-term fluctuations in exchange rates by calculating our net exposure to foreign
currencies on a daily basis on all of our transactions—sales and purchases—and by using derivatives to hedge that exposure.
In the past, the main instruments used for this purpose by us have been hedging contracts traded on the free market with maturities
of less than one year.
Interest Rate Exposure
We are most exposed to interest rate risk on the euro, the U.S. dollar and the pound sterling. Swaps are used to manage this risk
and control the cost of short- and medium-term debt. Interest-rate swaps are used primarily to restructure variable-rate debt and
substitute it with fixed-rate debt until maturity. The maturities of these swaps range from three months to five years depending on
the underlying debt. The interest-rate sensitivity of these instruments is calculated regularly.
Derivative Financial Instruments
Our business and financial transactions expose us to various market risks, primarily exchange rate and interest rate fluctuations.
For several years, our policy has been to systematically hedge exchange risks. A system for regularly reviewing and anticipating
market trends to hedge against interest rate risk has also been established. Our policy for managing market risk is based on
centralizing both systematic hedging and continuous monitoring, which enables the Group to take advantage of the best available
market conditions.
Exposure to Commodity Prices
Our exposure to commodity prices relates essentially to purchases of petrochemicals and natural gas. We can hedge against certain
of these risks by using swaps, options and futures that are accounted for on a market-to-market basis. As of December 31, 2005,
we held qualified derivatives to cover cash flow fluctuations as well as non-qualified covering derivatives.
The net fair value of our petroleum derivatives was €0.2 million as of December 31, 2005 and €1 million on December 31, 2004.
The fair value of qualified derivatives covering cash flow fluctuations, accounted for in place of “fair value reserves,” was €0.3 million
on December 31, 2005.
Sensitivity Analysis
We use derivatives to hedge our interest, raw material and exchange rate exposures. We calculate the sensitivity of these instruments
to financial markets over a one-year period on the basis of possible reasonable price fluctuations.
Financial instruments held by us that are sensitive to changes in interest rates include short-term debt and financial assets, interest
rate swaps and derivatives traded in organized over-the-counter markets. The analysis of the sensitivity is calculated on the basis
of an instantaneous 100 basis point interest rate increase in relation to year-end levels and all other things being equal.
118 Form 20 - F 2005 - Rhodia