Annual report: Period Ended 31 December 2012 - Invesco Perpetual

City Merchants High Yield Trust Limited 49
18. Financial Instruments
The Company’s financial instruments comprise its investment portfolio (as shown on pages 10 to 13),
cash, borrowings, other receivables and other payables that arise directly from its operations such as
sales and purchases awaiting settlement, derivatives and accrued income. The accounting policies in
note 2 include criteria for the recognition and the basis of measurement applied for financial
instruments. Note 2 also includes the basis on which income and expenses arising from financial
assets and liabilities are recognised and measured.
The principal risks that the Company faces in its portfolio management activities are set out below:
Market risk – arising from fluctuations in the fair value or future cash flows of a financial instrument
because of changes in market prices. Market risk comprises three types of risk: currency risk, interest
rate risk and other price risk:
Currency risk –
arising from fluctuations in the fair value or future cash flows of a financial
instrument because of changes in foreign exchange rates;
Interest rate risk – arising from fluctuations in the fair value or future cash flows of a financial
instrument because of changes in market interest rates; and
Other price risk – arising from fluctuations in the fair value or future cash flows of a financial
instrument for reasons other than changes in foreign exchange rates or
market interest rates.
Liquidity risk – arising from any difficulty in meeting obligations associated with financial liabilities.
Credit risk – arising from financial loss for a company where the other party to a financial
instrument fails to discharge an obligation.
Risk Management Policies and Procedures
The Directors have delegated to the Manager the management of the day-to-day investment activities,
borrowings and hedging of the Company as more fully described in the Report of the Directors.
As an investment company, investments include, but are not restricted to loan stocks, corporate
bonds, government stocks, preference shares and equities held for the long-term so as to comply with
its Investment Policy (incorporating the Company’s investment objective). In pursuing its investment
objective, the Company is exposed to a variety of risks that could result in either a reduction in the
Company’s net assets or a reduction of the profits available for dividends. The risks applicable to the
Company and the policies the Company uses to manage these risks for the period under review
follow.
Market Risk
As described on pages 22 to 23 in the Report of the Directors, high-yield fixed-interest securities are
subject to a variety of risks. Many of the Company’s investments are non-investment grade securities
and adverse changes in the financial position of an issuer or in the general economy may effect both
the principal and the interest. Gearing by using the Company’s borrowing facility can enhance
returns, however, this will also increase the Company’s exposure to market risk and volatility.
The portfolio managers assess the exposure to market risk when making each investment decision,
and monitor the overall level of market risk on the whole of the portfolio on an ongoing basis. Risk
management is an integral part of the investment management process. The portfolio managers
control risk by ensuring that the Company’s investment portfolio is appropriately diversified. In-depth
and continual analysis of market and stock fundamentals give the portfolio managers the best
possible understanding of the risks associated with a particular stock.