3. FINANCIAL RISK MANAGEMENT AND FINANCIAL INSTRUMENTS
3.3 Market risk

Market risk is the risk that changes in market prices (interest rate and currency risk) will affect the Group's income or the value of its holding of financial instruments. The objective of market risk management is to manage and control market risk exposures within acceptable parameters, while optimising the return.

The Group is exposed to risks from movements in interest rates and foreign exchange rates that affect its assets, liabilities and anticipated future transactions. The Group is not exposed to significant levels of price risk.

(i) Interest rate risk

The Group's cash flow interest rate risk arises from loans receivable, cash and cash equivalents, and borrowings carrying interest at variable rates. The Group is not exposed to fair value interest rate risk as the Group does not have any fixed interest-bearing instruments carried at fair value other than the instruments detailed in note 3.7 where the fair value risk of these instruments is detailed.

As part of the process of managing the Group's exposure to interest rate risk, interest rate characteristics of new borrowings and the refinancing of existing borrowings are positioned according to expected movements in interest rates.

Estimated change to profit or loss as a result of increase/decrease in market interest rates   2020 
R’000
 
 
2019 
R’000 
 
An increase or decrease in the market interest rates of 1% (100 basis points) would increase/decrease profit before tax by   27 473   18 491  

The interest rate sensitivity analysis is based on the following assumptions:

  • changes in market interest rates affect the interest income or expense of variable interest financial instruments; and
  • changes in market interest rates only affect interest income or expense in relation to financial instruments with fixed interest rates if these are recognised at fair value.

(ii) Foreign currency risk

The Group is exposed to foreign currency risk from transactions and translations. Transaction exposure arises because affiliated companies undertake transactions in currencies other than their functional currency. Translation exposure arises where affiliated companies have a functional currency other than rand.

The Group manages its exposure to foreign currency risk by ensuring that the net foreign currency exposure remains within acceptable levels. Hedging instruments may be used in certain instances to reduce risks arising from foreign currency fluctuations.

In the current year, the Group incurred a foreign exchange gain of R40.7 million (2019: R37.1 million loss) mainly as a result of the Group's USD exposure.

Foreign currency sensitivity analysis

The Group has used a sensitivity analysis technique that measures the estimated change to profit or loss of an instantaneous 10% strengthening or weakening in the rand against all other currencies, from the rate applicable at 31 May 2020, for each class of financial instrument with all other variables remaining constant. This analysis is for illustrative purposes only, as in practice, market rates rarely change in isolation.

          (Decrease)/increase in
profit before tax
 
Net exposure to foreign currencies   Net assets/ 
(liabilities)
denominated 
in foreign 
currency 
  Change in 
exchange 
rate 
  Weakening 
in functional 
currency 
  Strengthening 
in functional 
currency 
 
Denominated:functional currency   R’000      R’000    R’000   
2020                  
USD:ZAR   (333 183)   10    (33 318)   33 318   
NAD:ZAR   (31)   10    (3)    
    (333 214)       (33 321)   33 321