Notes to the Consolidated Balance Sheets

The carrying amounts and fair values of financial assets and liabilities belonging to the various measurement categories, classified by balance sheet category and non-current and current items, are as follows:

Abbreviations

• AfS, available for sale
• FLAC, financial liability at amortized cost
• HfT, held for trading
• LaR, loans and receivables

Financial instruments belonging to the held for trading category are measured at their fair value. Financial instruments belonging to the available for sale category are also measured at their fair value, unless this cannot be reliably measured, in which case the financial assets are measured at cost.

Cash and cash equivalents, trade receivables, trade payables and other financial liabilities, generally have short remaining maturities. As a result, the carrying amounts at the closing date correspond approximately to the fair value.

Derivative financial instruments which meet the requirements of hedge accounting are not allocated to any IAS 39 measurement category, since they are explicitly excluded from the individual measurement categories.

Derivative financial instruments for which hedge accounting is not applied are classified as financial assets and liabilities held for trading.

The fair values of other indebtedness and of liabilities from finance leases were determined by discounting all future cash flows at the applicable interest rates for the corresponding residual maturities, taking into account a company-specific rating spread.

The sum of the positive carrying amounts is equivalent to the maximum default risk of the Continental Corporation from financial assets. To secure trade accounts receivable, trade credit insurance has been agreed, among other things.

The financial instruments measured at fair value are shown in the table below in accordance with their measurement method. The levels of the fair value hierarchy are defined as follows:

• Level 1: quoted prices on the active market for identical instruments
• Level 2: quoted prices on the active market for a similar instrument or a measurement method for which all major input factors are based on observable market data
• Level 3: measurement method for which the major input factors are not based on observable market data

There are currently no financial assets in the Continental Corporation which are measured according to Level 3 of the fair value hierarchy. No transfers were made between different levels of the fair value hierarchy.

The net gains and losses by measurement category were as follows:

Interest income from financial instruments is reported in net interest expense (Note 9). No interest income was generated from impaired financial assets.

The valuation allowance for loans and receivables results from trade accounts receivable. Gains and losses on financial assets and liabilities held for trading that were determined during subsequent measurement include both interest rate and exchange rate effects.

The changes in value of the financial assets designated as available for sale that were recognized directly in equity amounted to -€2.2 million in 2011 (PY: -€0.6 million); no amount (PY: €0.0 million) was taken from equity and recognized in income during the fiscal year.

Collateral
As of December 31, 2011, a total of €2,077.1 million (PY: €1,725.7 million) of financial assets had been pledged as collateral. As in the previous year, collateral mainly consists of trade accounts receivable; the remainder relates to pledged cash or other financial assets in the year under review. Trade receivables sold under factoring programs as well as the aforementioned collateral in the form of trade receivables are shown in Note 20.

As agreed in 2009 in the renegotiation of the syndicated loan, Continental AG and selected subsidiaries granted the lending banks a collateral package. This consists of guarantees by certain subsidiaries, the pledging of shares in the guaranteeing subsidiaries, certain account balances and the transfer of internal claims. No further collateral was provided in this context. The bonds issued in the previous year with a total volume of €3.0 billion and a defined portion of the bilateral lines of credit with banks in the corporation also participate in this collateral package.

Hedging policy and financial derivatives
The international nature of its business activities and the resulting financing requirements mean that the corporation is exposed to exchange rate and interest rate fluctuations. Where foreign currency risks are not fully compensated by offsetting delivery and payment flows, exchange rate forecasts are constantly updated to ensure that risks can be hedged as necessary in individual cases using appropriate financial instruments. In addition, long- and short-term interest rate movements are continuously monitored and are controlled by using derivative financial instruments. Thus, interest rate and currency derivatives allow debt to be accessed with any required interest and currency structure, regardless of the location at which the financing is required.

The use of hedging instruments is covered by corporate-wide guidelines, adherence to which is regularly reviewed by internal audit. Internal settlement risks are minimized through the clear segregation of functional areas.

1. Currency management
The international nature of the corporation's business activities results in deliveries and payments in various currencies. Currency exchange fluctuations involve the risk of losses because assets denominated in currencies with a falling exchange rate lose value, while liabilities denominated in currencies with a rising exchange rate become more expensive. At Continental the net exposure, calculated primarily by offsetting exports against imports in the individual currencies, is regularly recorded and measured. For many years now, the corporation has been using natural hedges to reduce currency risks so that the difference between receipts and payments in any one currency is kept as low as possible. Expected exchange rate developments are also monitored and analyzed accordingly. Exchange rate risks are hedged as necessary using appropriate financial instruments. Currency management sets tight limits for open positions and thus considerably reduces the hedging risk. For hedging, it is allowed to use only those derivative financial instruments that can be reported and measured in the risk management system. Financial instruments that do not meet these criteria may not be used at all. The corporation's net foreign investments are generally not hedged against exchange rate fluctuations.

Operational foreign currency risk
Continental compiles its subsidiaries' actual and expected foreign currency payments at a global level for currency management purposes. These amounts represent the corporation's transaction exposure and are measured as the net cash flow per currency on a rolling 12-month forward basis. The foreign exchange and interest rate committee convenes weekly to review and initiate hedging measures. These may not exceed 30% of the 12-month exposure per currency without the express permission of the Executive Board.

Financial foreign currency risks
In addition, currency risks also result from external and internal loan agreements that are denominated in a currency different from the functional currency of the respective subsidiary. These currency risks are generally hedged against through the use of derivative financial instruments, particularly currency forwards, currency swaps and cross-currency interest rate swaps.

Sensitivity analysis
IFRS 7 requires a presentation of the effects of hypothetical changes of currency prices on earnings and equity using sensitivity analyses. The changes to the currency prices are related to all financial instruments outstanding on the reporting date. Expected transactions are not included in the sensitivity analysis. To determine the transaction-related net foreign currency risk, the financial instruments are categorized according to foreign currency for this portfolio and a 10% appreciation or depreciation of the respective functional currency of the subsidiaries is assumed in relation to the foreign currency. The table below shows – before income taxes – the overall effect as measured using this approach, as well as the individual effects resulting from the euro and the U.S. dollar as major transaction currencies, on the difference from currency translation from financial instruments in equity and on net income.

Effects of translation-related currency risk
A large number of the subsidiaries are located outside the euro currency zone. Since Continental AG's reporting currency is the euro, the financial statements of these companies are translated into euros. In order to address translation-related currency effects as part of risk management, it is assumed that investments in foreign companies are generally entered into for the long term and that earnings are reinvested. Translation-related effects that arise when the value of net asset items translated into euros changes as a result of currency fluctuations are taken to equity in the consolidated financial statements.

2. Interest rate management
Variable interest agreements pose the risk of rising interest rates for liabilities and falling interest rates for interest-bearing financial investments. These risks are monitored and evaluated as part of our interest rate management activities and managed by means of derivative interest rate hedging instruments. The corporation's interest-bearing net indebtedness is the subject of these activities. All interest rate hedges serve exclusively to manage identified interest rate risks. One of the goals is to keep around 50% to 75% of gross interest-bearing debt at a fixed interest rate.

The corporation is not exposed to a risk of fluctuation in the fair value of long-term financial liabilities due to market changes in fixed interest rates, as the lenders do not have the right to demand early repayment in the event of changing rates. If the corporation has the right to redeem instruments before maturity, such redemption is considered only if this is advantageous from the Continental Corporation's perspective.

Interest rate risk
The profile of interest-bearing financial instruments allocated to net indebtedness, taking into account the effect of the Continental Corporation's derivative financial instruments, is as follows:

The Continental Corporation has entered into interest rate derivatives which were classified as effective cash flow hedges as of December 31, 2010. Hedge accounting was no longer applied as of December 31, 2011. As a result, a change in interest rates at the end of fiscal 2011 would only have affected the income statement (net interest expense) as of December 31, 2011, whereas, in the previous year it would also have had an effect on equity.

In line with IFRS 7, effects of financial instruments on earnings and equity resulting from interest rate changes must be presented using sensitivity analyses.

Fair value sensitivity analysis
An increase in interest rates of 100 basis points in 2011 would have led to a €4.3 million (PY: €20.3 million) deterioration in net interest expense. In the previous year, there would also have been a €50.1 million increase in the difference from financial instruments in equity.

A decline in interest rates of 100 basis points would have improved net interest expense by €16.5 million (PY: €32.0 million). The decrease in the difference from financial instruments in equity would have amounted to €49.2 million in the previous year. This analysis assumes that interest rates cannot be lower than or equal to 0%. Tax effects have not been taken into account.

The effects described are almost entirely due to changes in interest rates for the euro.

Cash flow sensitivity analysis
An increase in interest rates of 100 basis points in 2011 would have led to a €1.1 million (PY: €2.9 million) deterioration in net interest expense, while a decline in interest rates of 100 basis points would have led to an improvement in net interest expense of €1.1 million (PY: €2.9 million). The effects result essentially from floating-rate financial instruments in the currencies euro, U.S. dollar, Chinese renminbi and Korean won.

This analysis is based on the assumption that all other variables, and in particular exchange rates, remain unchanged. The same assumption applied to 2010.

3. Counterparty risk
Derivative financial instruments are subject to default risk to the extent that counterparties may not meet their payment obligations either in part or in full. To limit this risk, contracts are entered into with selected banks only. The development of contractual partners' creditworthiness is continuously monitored, particularly by monitoring the rating classifications and the market assessment of default risk using the respective credit default swap rates.

4. Liquidity risks
A liquidity forecast is prepared by central cash management on a regular basis.

Cost-effective, adequate financing is necessary for the subsidiaries' operating business. Various marketable financial instruments are employed for this purpose. These comprise overnight money, term deposits, commercial paper, factoring programs as well as the syndicated loan with the nominal amount of €5,375.0 million (PY: €6,484.9 million) and other bilateral loans. Furthermore, around a third of gross indebtedness is financed on the capital market in the form of bonds. Capital expenditure by subsidiaries is primarily financed through equity and loans from banks or subsidiaries. There are also cash-pooling arrangements with subsidiaries to the extent they are possible and justifiable in the relevant legal and tax situation. Should events lead to unexpected financing requirements, Continental AG can draw upon existing liquidity and fixed credit lines from banks. For detailed information on the existing used and unused loan commitments, please refer to Note 28.

The following undiscounted cash outflows result in the next five years and after from the financial liabilities of €14,097.0 million (PY: €13,705.2 million):

In the analysis, foreign currency amounts were translated with the spot exchange rate current at the time of the reporting date into euros. For floating-rate non-derivative financial instruments, the future interest payment flows were forecasted using the most recently contractually fixed interest rates. Forward interest rates were used to determine the floating rate payments for derivative financial instruments. The analysis only includes payment outflows from financial liabilities. For derivative financial instruments showing a negative fair value on the balance sheet date, the net payments are reported. Payment inflows from financial assets were not accounted for.

The payment outflows in the maturity analysis are not expected to occur at significantly different reference dates or in significantly different amounts.

5. Default risk
Credit risk from trade accounts receivable and financial amounts receivable includes the risk that amounts receivable will be collected late or not at all. These risks are analyzed and monitored by central and local credit managers. The responsibilities of the central credit management function also include pooled accounts receivable risk management. Contractual partners' creditworthiness and payment history are analyzed on a regular basis. However, default risk cannot be excluded with absolute certainty, and any remaining risk is addressed by establishing portfolio valuation allowances on the basis of experience or charging impairment losses for specific individual risks. Default risk for non-derivative financial amounts receivable is also limited by ensuring that agreements are entered into with partners with proven creditworthiness only or that collateral is provided or trade credit insurance is agreed. Please see Note 20 for information on determining creditworthiness. Financial assets that are neither past due nor impaired accordingly have a prime credit rating.

Further information about risks and risk management can be found in the "Risk Report" section of the Management Report.

Measurement of derivative financial instruments
Derivative financial instruments are recognized at fair value, which is generally determined by discounting the expected cash flows on the basis of yield curves. For example, the fair value of currency forwards is calculated as the difference from the nominal amounts discounted with the risk-free interest rates of the respective currencies and translated at the current spot exchange rate. To calculate the fair value of interest rate swaps and cross-currency interest rate swaps, the future cash flows are discounted with the interest rates for the respective maturities, with deposit rates used as short-term interest rates whilst long-term interest rates are based on the swap rates in the respective currency.

As of December 31, 2011, positive fair values of €105.6 million (PY: €67.6 million) and negative fair values of €1.8 million (PY: -€0.8 million) were recognized for embedded derivatives. These essentially relate to the reporting of call options for the bonds issued by Conti-Gummi Finance B.V., Maastricht, Netherlands, in 2010. The options were measured using the Black model. A risk-free interest curve, adjusted for Continental AG's credit risk, was used in the calculation. The volatility of the Continental AG refinancing rate was determined approximately using swaption volatilities. The recognized amortized cost of the bonds take into account the value determined on emission for the embedded options. The following overview shows the fair values and nominal values of the free-standing derivatives as of the balance sheet date.

In the case of highly effective and longer term hedges, Continental usually applies hedge accounting as set out in IAS 39. For cash flow hedges, changes in the market value of the derivatives are taken directly to other comprehensive income in total equity until the hedged item is recognized in income.

As of the end of July 2011, the cash flow hedge accounting for the partial amount of €2.5 billion of the tranche of the syndicated loan due in April 2014 was voluntarily terminated prematurely. Changes in the fair value of these hedges are now recognized directly in profit or loss. Income of €16.9 million has arisen since the de-designation of the cash flow hedges. Changes in value recognized in equity as a difference arising from financial instruments for the hedges by the end of July 2011 are reversed over the remaining term of the hedges. As of December 31, 2011, an expense of €25.1 million was recognized in the net interest expense.

At the end of December 2011, hedge accounting for the partial amount of €625.0 million was terminated on account of the early repayment of the tranche of the syndicated loan originally due in August 2012. Changes in the fair value of these hedges are now recognized directly in profit or loss. An expense of €7.3 million has been incurred since the reversal of the cash flow hedges. Changes in value recognized in equity as a difference arising from financial instruments for the hedges by the end of December 2011 were recognized in full in profit or loss. This resulted in an increase of €14.2 million in net interest expense. There is still an economically effective hedge as the tranche repaid early at the end of December 2011 was refinanced in full by utilizing the revolving tranche of the syndicated loan, and the parameters of this utilization are still consistent with those of the interest hedge.

Changes in the difference from cash flow hedges are as follows:

The prospective and retrospective effectiveness of hedges was demonstrated through regular effectiveness testing up to the termination of hedge accounting. The dollar offset method was used to determine retrospective effectiveness. This calculated the ratio of the fair value changes or changes in cash flow of the hedged underlying transaction to the fair value changes or changes in cash flow of the hedging transaction. The results of retrospective effectiveness testing fell within a range of 80% to 125%, meaning that the hedges used by the corporation could be considered highly effective. As in the previous year, no ineffectiveness arose from the cash flow hedges during the year under review.

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