28. MANAGEMENT OF FINANCIAL RISKS               RISK MANAGEMENT IN FINNAIR               Principles of financial risk management               The nature of Finnair Group's business operations exposes the company to foreign exchange, interest rate, credit and liquidity and jet fuel price risks. The Group's policy is to limit the uncertainty caused by such risks on cash flow, financial performance and equity.               The management of financial risks is based on the risk management policy approved by the Board of Directors in November 2004, which specifies the minimum and maximum levels permitted for each type of risk. Financial risk management is directed and supervised by the Financial Risk Steering Group. Practical implementation of financial policy and risk management have been centralised in the parent company's finance department.               In its management of foreign exchange, interest rate and jet fuel positions the company uses different derivative instruments, such as forward contracts, swaps and options. Derivatives are designated at inception as hedges for future cash flows and binding purchase contracts (cash flow hedges) or as financial derivatives not qualifying for hedge accounting (economic hedges). Foreign currency hedging of the price and foreign currency risk of jet fuels, lease payments and aircraft purchases as well as hedging of fixed-interest foreign currency loans is implemented as cash flow hedging according to IAS 39 hedge accounting principles.               Jet fuel price risk in flight operations               Jet fuel price risk means the cash flow and financial performance uncertainty arising from jet fuel price fluctuations.               Finnair hedges against jet fuel price fluctuations solely with jet fuel forward contracts and options, whose underlying asset is Jet Fuel CIF Cargoes NWE. Around 70% of Finnair's jet fuel purchase contracts are based on this benchmark price index of Northern and Western Europe jet fuel deliveries. Crude oil and gasoil derivatives are not used at present.               In its jet fuel hedging, Finnair follows the time-diversification principle and a two-year hedging period. Under the risk management policy, hedging must be increased in each quarter of the year so that the degree of hedging for scheduled traffic (Finnair Plc's scheduled traffic, Aero & FlyNordic) is more than 50% the next six months. By allocating the hedging, the jet fuel cost per period is not as low as the spot-based price when prices fall, but when spot prices rise the fuel cost rises more slowly.               Jet fuel hedges are recognised in Finnair in two different ways. In terms of the fuel consumption of Finnair's scheduled traffic, the first approximately 35 percentage points are treated in accounting as a cash-flow hedging in accordance with IAS 39 hedge accounting principles. The fair value change recognised in equity (hedging reserve) are transferred to the income statement in the same period in which the hedged item is entered in the income statement. Fair value changes of hedges changes in the fair value hedgings not qualifying for IAS-39 hedge accounting criteria are recognised in the other operating expenses also during their term to maturity. The sensitivity figures presented below include both recognition types hedge.               At the end of financial year, scheduled passenger traffic had hedged 60% of its jet fuel purchases for the first six months of 2006 and 41% for the second half of the year. Due to a curent agreement with tour operators, leisure traffic did not separately hedge its fuel purchases on the closing date. A price clause in the said agreement protects leisure traffic's operating profit from significant rises in jet fuel pricel.               In the financial year 2005, jet fuel used in flight operations accounted for 16.0% of the Group's operating costs. On the closing date a ten per cent rise in the market price of jet fuel increases - excluding hedging activity calculated using scheduled passenger traffic's forecast number of flights for 2006 - annual fuel costs by an estimated 33 million euros. On the closing date - taking hedging into account - a ten per cent rise in fuel increases costs by around 17 million euros.               Foreign exchange risk               Foreign exchange risk means the cash flow and financial performance uncertainty arising from exchange rate fluctuations. The Finnair Group's foreign exchange risk arises mainly from jet fuel and aircraft purchases and aircraft leasing payments.               The Group's policy is to reduce the foreign exchange risk affecting cash flow for the next 12 months to an acceptable level. In addition Finnair hedges risk that exceeds 12 months in terms of binding purchase agreements for aircraft (IAS 39 cash-flow hedging) and fuel purchases (IAS 39 cash-flow hedging).               Around 68% of Group turnover is denominated in euros. The most important other foreign sales currencies are the US dollar, the British pound, the Japanese yen and the Swedish crown.               Approximately 35% of the Group's operating costs are denominated in foreign currencies. The most important purchasing currency is the US dollar, which accounts for 65% all operating costs denominated in foreign currency. Significant dollar-denominated expense items are aircraft leasing payments and jet fuel costs. The largest capital investments, the acquisition of aircraft and their spare parts, also take place mainly in US dollars.               On the closing date, a 10 per cent weakening of the dollar against the euro - without hedging - has a positive impact on the result of 32 million euros. On the closing date - taking hedging into account - a 110 per cent weakening of the dollar improves the result by around 3 million euros. A strengthening of the dollar correspondingly weakens the result. In the above sensitivity estimates, the dollar risk includes the substantial sales currencies the Chinese yuan and the Hong Kong dollar, whose historical correlation with the dollar is over 95 per cent.               Interest risk               Interest rate risk means the cash flow and financial performance uncertainty arising from interest rate fluctuations.               In Finnair Group the interest rate risk is measured using the interest rate re-fixing time tying time. If necessary, interest rate derivatives are used for the interest rate re-fixing time. The mandate for the investment portfolio's to interest rate re-fixing time is 0 -12 months and for interest-bearing liabilities 12 - 24 months. On the closing date the investment portfolio's interest rate re-fixing time was 0 -12 months and for interest-bearing liabilities 12 - 24 months. On the closing date a one percentage point rise in interest rates increases the annual interest income of the investment portfolio by 3.2 million euros and the interest expenses of the loan portfolio by 0.5 million euros. At the end of financial year 2005, the average interest rate on the Group's interest-bearing loans was 3.6%.               Credit risk               The Group is exposed to counterparty risk when investing its cash reserves and in using derivative instruments. The credit risk is managed by making contracts, within the framework of counterparty risk limits, only with financially sound domestic and foreign banks, financial institutions and brokers. Liquid assets are also invested in commercial papers and bonds issued by conservatively selected companies.               Liquidity risk               The goal of the Finnair Group is to maintain good liquidity. Liquidity is ensured by cash reserves, bank account limits, liquid money market investments and committed credit facilities. In terms of aircraft purchases, the company's policy is to secure, the sources of finance minimum six months prior to delivery.               The Group's liquid assets were 410.5 million euros at the end of financial year 2005. In addition, Finnair Plc had the following unused credit facilities on the closing date: a domestic commercial paper programme of 100 million euros and a committed EUR 200 million credit limit. The credit limit facility includes a finance covenant based on adjusted gearing. The covenant level of adjusted gearing is 175%, while at the closing date the figure was 66.8%. The maximum level set by the Board of Directors is 140 per cent.               FOREIGN EXCHANGE RISK 31.12.2005 31.12.2005           Currency derivatives Nominal value EUR mill. Fair value EUR mill.           Hedge accounting items:               hedging of jet fuel currency 168.5 9.4           Hedging of aircraft purchases 191.6 5.5           Hedging of lease payments 55.2 2.8           Total 415.3 17.7                           Items outside hedge accounting:               Cash-flow hedging 107.5 4.7           Balance sheet hedging 117.9 1.3           Total 225.4 6.0                           The fair value changes of derivates that fulfil the terms of IAS-39 hedge accounting principles are entered directly in hedging reserve of equity. The gains and losses recognized in equity are transferred to the income statement in the period in which the hedged item is entered in the income statement. If a forecast transaction is no longer expected to occur any gain or loss is released immediately to the income statement. Fair value changes of derivatives hedging future cash flows (for which IAS-39 hedge accounting is not applied) are presented in profit and loss in other operating expense and the fair value changes of derivatives hedging balance sheet (for which IAS-39 hedge accounting is not applied) are presented in the financial items.               Jet fuel price risk in flight operations 31.12.2005 31.12.2005           Fuel price risk means the cash flow and financial performance uncertainty arising from fuel price fluctuations. Nominal värden EUR mill. Fair value           Hedge accounting items:               Jet fuel forward contracts (tonnes) 351,800 11.6                           Items outside hedge accounting:               Jet fuel forward contracts (tonnes) 71,700 -2.8           Jet fuel options (tonnes)               Bought 12,000 0.2           Sold 12,000 -0.1                           Fair value changes of commodity derivatives in hedge accounting are recognised in the equity hedging reserve from where it is offset against the hedged item.                               Fair value changes of commodity derivatives outside hedge accounting are recognised in the income statement item other operating expenses.               INTEREST RATE RISK                               The Group's fixed-interest USD-denominated aircraft financing liabilities have been hedged with long-term currency and interest rate swap contracts. The difference of the nominal and fair value of the fixed-rate derivative contracts is recognised in the equity hedging reserve, and the aircraft financing loans which are the underlying asset are recognised at their nominal value. Fair value changes of variable-interest derivatives and the underlying loans are presented in the profit and loss in the financial items.               The foreign exchange risk of variable-interest USD loans is covered by short-term currency derivatives.                               The carrying amounts of interest-bearing liabilities (bank loans, pension loans) - including long-term currency and interest rate swap contracts the loans - were divided on 31 December 2005 by currency as follows:                               The nominal values of interest-bearing net liabilities (incl. derivatives) are distributed by currency on 31 Dec 2005 as follows:                                               Currency Milj euroa             EUR 193.6             USD 50.6             Total 244.2                               31.12.2005 31.12.2005           Currency and interest rate swap contracts Nominal value EUR mill. Fair value EUR mill.           Hedge accounting items: 61.4 -14.2           Items outside hedge accounting: 30.1 -9.6             91.5 -23.8           Maturity dates of fair values recognised in the hedging reserve: 2006 2007 2008 2009 2010 Later Total Jet fuel price hedging 9.2 2.2 0.2       11.6 Foreign exchange hedging of jet fuel 7.7 1.7         9.4 Currency hedging unforced of lease payments 2.8           2.8 Currency hedging of aircrafts purchases 5.7 -0.2         5.5 Currency and interest rate swap contracts -0.3 -0.2 -0.2 -0.1 -0.1 -0.1 -1.0               28.3 The currency and interest rate swap contracts in hedge accounting are recognised in terms of exchange rate differences identically with the hedged loans. Of the -14.2 million euro fair value of derivative contracts, -13.2 million euros has been recognised in the income statement of 2005 and earlier financial years in the same row with the hedged loan. On the closing date -1.0 million euros had been recognised in the hedging reserve.               VALUATION PRINCIPLE OF FINANCIAL INSTRUMENTS                               Derivate instruments are measured at fair value, which is determined as the value at which an asset could be exchanged, or a liability settled, between knowledgeable, willing and independent parties in an unforced transaction on both sides. The value of these derivates is determined as follows: The fair values of all derivatives are calculated using the exchange rates, interest rates, volatilities and commodity price quotations on the closing date. The fair values of currency forward contracts are calculated at the present value of future cash flows. The fair values of currency options are calculated using generally accepted option valuation models. The fair values of interest rate swap contracts are calculated at the present value of future cash flows. The fair values of interest rate and currency swap contracts are calculated at the present value of future cash flows. The fair values of interest rate options are calculated using generally accepted option valuation models. The fair values of commodity contracts are calculated at the present value of future cash flows. The fair value of commodity options are calculated using generally accepted option valuation models.               The fair values of all derivatives are calculated using the exchange rates, interest rates, volatilities and commodity price quotations on the closing date. The fair values of currency forward contracts are calculated at the present value of future cash flows. The fair values of currency options are calculated using generally accepted option valuation models. The fair values of interest rate swap contracts are calculated at the present value of future cash flows. The fair values of interest rate and currency swap contracts are calculated at the present value of future cash flows. The fair values of interest rate options are calculated using generally accepted option valuation models. The fair values of commodity contracts are calculated at the present value of future cash flows. The fair value of commodity options are calculated using generally accepted option valuation models.