Market risk and the use of derivative financial instruments

As an international company, Software AG operates in a variety of currency zones and is therefore subject to exchange rate risks. Management continuously monitors these risks. Derivative financial instruments are used in accordance with internal guidelines in order to reduce risks arising from changes in interest rates, exchange rates, or the value of financial investments. Hedging transactions using derivatives are entered into to cover existing risk positions and highly probable forecast transactions.

a) Interest rate risks

The Company is subject to interest rate fluctuations. Since there are no loan liabilities, interest rate risks only apply to cash and cash equivalents held by the Group.

Changes in the market interest rates result in changes in net interest income due to the focus on financial investments with short-term maturities and investments with little fluctuation in value. In order to mitigate this dependency, interest rate derivatives, primarily forward rate agreements or swaps, are used to an extremely limited degree. These are measured at their market value, with changes recognized in profit or loss.

b) Exchange rate risks

In order to hedge the risk of future fluctuations in exchange rates, the Company enters into currency forwards and currency option transactions. In addition to simple euro call options, combinations of euro call options purchased and euro put options sold are also utilized. The premium payments generally offset each other. Foreign currency receivables and liabilities are offset if possible, and only the remaining net exposure is hedged. Expected cash flows are also hedged in accordance with internal guidelines.

Hedging transactions are measured at their market value. The amounts are reported in the balance sheet under other assets or current liabilities. Changes in the market value of derivative financial instruments designated to hedge future foreign currency cash flows are reported under other reserves until the hedged item is required to be recognized in income. The ineffective portions of cash flow hedges as well as changes in the value of hedging instruments that do not meet the requirements of hedge accounting are recognized immediately in profit or loss for the year in which they are incurred.

c) Risk of changes in value

In line with the Groups policy, assets are controlled in terms of maturity, interest type, and rating such that the Company does not expect any significant fluctuations in value.

d) Credit risk

Software AG is exposed to default risk if contracting parties fail to meet their obligations. All financial instruments are entered into with banks having very good credit ratings. We consider the default risk of our business partners to be extremely low./p>

Volume and measurement of derivative financial instruments

The tables below show the transaction volumes and market values of derivative financial instruments as of December 31, 2006, and December 31, 2005. The market value of the financial instruments is based on the figures supplied by the respective banks and is equivalent to the replacement cost as of the balance sheet date.

Effects on income/expense resulting from the market valuation of financial instruments: Financial instruments (fair value hedges )
	Currency	Transaction volume		Positive market value		Negative market value
€ thousands		2006	2005	2006	2005	2006	2005
Forward currency contracts	GBP	1,037	0	0	0	4	0
	USD	1,577	2,458	65	0	0	70
Currency options	USD	3,189	2,492	136	21	1	0
Interest rate swaps	EUR	5,000	0	0	0	42	0
Stock options	EUR	2,308	0	675	0	0	0

The financial instruments presented in the table above are designated to hedge the fair value of recognized assets or liabilities (fair value hedges). Changes in the fair value are recognized in profit or loss.

In order to hedge the cash flow risks arising from the phantom share program, the Company has acquired derivative financial instruments on Software AG stock from banks. The resulting changes in market value reduce the fluctuations in value of the phantom share plan commitments in relation to the performance of Software AG stock. The positive market value of these financial instruments is offset against the negative market value of commitments arising from the phantom share plan and reported as personnel expenses.

In addition, the Company has entered into cash flow hedges for forecast transactions. Changes in the fair value of such financial instruments are reported under other reserves. As soon as the forecast hedged transaction occurs, the changes in the fair values reported under other reserves are reclassified and recognized in profit or loss.

Effects on other reserves resulting from the market valuation of financial instruments:

Financial instruments (cash flow hedges )
	Currency	Transaction volume		Positive market value		Negative market value
€ thousands		2006	2005	2006	2005	2006	2005
Forward currency contracts	USD	3,920	9,885	139	9	0	164

The maximum default risk from existing hedge transactions is equivalent to the market values recognized in the balance sheet.

The financial instruments for hedging interest rate and currency risks have remaining maturities of less than one year. Stock options for hedging commitments from the phantom share plan have maturities extending no later than February 2009.

Derivative financial instruments are used only to hedge existing or expected interest rate risks, currency risks, or other market risks.

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