## 5. Financial instruments 

## 1. Concerning the situation of financial instruments 

## (1) Policy for dealing financial instruments 

Daiwa, the primary businesses of which are investment and financial services businesses with a core focus on securities related business, is involved in trading and brokerage of securities and derivative prod- ucts, underwriting and secondary offering of securities, treating public offerings for subscription and secondary offering of securities, treating of private offerings for subscription of securities, and banking busi- ness or other businesses related to the securities and financial fields. 

Daiwa holds financial assets and liabilities as follows to execute its businesses: securities, derivatives, operational investment securities, loans and investment securities, etc. and raises its capital utilizing a variety of financial instruments such as corporate bonds, medium- term notes, borrowing from financial institutions, deposits, etc. Under the basic policy for financing that enough liquidity for continuing busi- ness should be effectively secured, Daiwa is maintaining an appropri- ate balance between assets and liabilities by diversifying financial measures and maturity dates, and realizing effective and stable financing when it decides to raise its capital. Also, Daiwa uses interest rate swaps and foreign currency swaps, etc. for the purpose of hedg- ing fluctuation of interest rates and foreign currencies in terms of financial assets and liabilities. 

Daiwa entirely and efficiently manages the variety of risks incurred by holding financial assets and liabilities and maintains sound finances. 

## (2) Contents and risk of financial instruments 

Daiwa holds financial instruments in the trading business as follows: 

(a) trading securities and others (stocks and warrants, bonds and units of investment trusts), loans secured by securities and loans payable secured by securities, margin transaction assets and liabili- ties, (b) derivatives, traded on exchanges, such as stock index futures, bond futures, interest rate futures and options for those, (c) derivatives (OTC derivatives), not traded on exchanges, such as interest rate and foreign exchange swaps, foreign currency futures, currency options, bond options, FRA and OTC securities derivatives, etc. And Daiwa holds operational investment securities, etc. in the principal investments business and venture capital business, loans and securities, etc. in the banking business and investment securities for the business relationship, etc. 

Of the various risks, the major risks implied in these financial instru- ments are market risk and credit risk. Market risk means the risks of suffering losses from fluctuations in the value of holding financial instruments and transactions in accordance with changes of market prices of interest rates, currency exchange rates and stock prices, etc. and from the market environment in which no transaction can be executed because of an excessive decrease of liquidity or one in which market participants are focused to trade in extremely unfavor- able conditions. Credit risk means the risk of suffering losses from defaults or credit changing of counterparts or issuers of financial instruments which Daiwa holds, etc. 

In the trading business, Daiwa conducts derivative transactions solely and as a part of structured notes to meet customers’ needs. 

These include transactions which are volatile because of the correla- tion with stock indices, foreign exchange rates and interest rates of reference assets or which tend to move in a complicated manner. Therefore, these carry higher risk than the reference assets. These derivative transactions are categorized as trading assets in the con- solidated balance sheets and the realized and unrealized profit/loss by fluctuation of fair values are recorded as the net gain on trading. 

Daiwa is raising its capital utilizing corporate bonds, medium-term notes, borrowing from financial institutions, deposits, etc., as well as holding its financial instruments, and is exposed to liquidity risk. Liquidity risk indicates the risk of suffering losses such that cash management may be impossible and remarkably higher financing costs than usual may be requested as a result of an abrupt change of market environment or unexpected credit crunch of Daiwa, etc. 

Subsidiaries engaged in the trading business utilize derivative transactions as brokers and end-users. Derivative products have been necessary to deal with a variety of customers’ financial needs and subsidiaries engaged in the trading business provide customers with financial instruments to meet their customers’ requests in many ways as brokers. For instance, they provide customers with foreign cur- rency futures to hedge the exchange rate risk of foreign currency of foreign bonds held by customers and interest rate swaps to hedge interest rates when customers issue corporate bonds, etc. As end- users, they use interest rate swaps to hedge interest rate risk regard- ing financial assets and liabilities of Daiwa and utilize many kinds of futures and options to hedge their trading positions. 

## (3) Risk management system concerning financial instruments 

For risk management of Daiwa, the Company has resolved the “Risk Management Rule” at the meeting of the Board of Directors which states the basic policy of risk management, types of risks that should be managed and responsible executive officers and department for each major risk. Each subsidiary conducts risk management suitable for each business profile and size in accordance with the basic policy of risk management. And the Company monitors the structure and process of subsidiaries’ risk management. Also, the Group Risk Management Committee as a sub-committee of the Executive Committee of the Company receives reports on matters such as risk exposure obtained by monitoring of subsidiaries and issues concern- ing the risk management system of each subsidiary and discusses them. Subsidiaries regularly hold risk management committee meet- ings, etc., and strengthen each risk management system. 

(i) Management of risk of financial instruments held for trading purpose 

(a) Management of market risk 

The Group manages its trading positions by establishing the limit for VaR which indicates the estimate of the maximum loss amount under a certain probability, position and sensibility etc. considering the financial situation, the business plan and budget of each division. The risk management department of the Company recognizes the market risk of Daiwa and informs the management of the Company on a daily basis. In order to cover the capacity limit of VaR calculated by the statistical 

