Pursuant
to a requirement of the Mexican Securities and Exchange Commission or CNBV
(¨Comisión Nacional Bancaria y
de Valores¨) applicable to all issuers, we hereby present the following
Quantitative and Qualitative Disclosure of Derivative Financial Instruments of
Fomento Económico Mexicano, S.A.B de C.V. (“FEMSA”) as of September 30,
2008:
i)
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Management
Discussion of Financial Derivative Instruments
Policies:
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The
Company allows, as part of its Risk Management Policy, the use of derivative
financial instruments, to reduce operating risk and uncertainty of operating and
financial volatility. The Company does not use derivative instruments
for speculative purposes; although, given Mexican accounting guidelines
regarding hedging positions, some instruments may not qualify as accounting
hedges.
The
company solely executes derivative transactions with institutions it deems to
have an appropriate credit profile and it enters into these transactions through
standardized ISDA Contracts for Financial
Derivative Transactions, Global Derivatives Contract, or similar
documentation.
As part
of the internal control processes of its Risk Management Policy, the Company has
a Finance Committee that reports to the Board of Directors. Among the duties of
the Finance Committee is to define the financial strategy for the Company and to
evaluate risk management practices, including in connection with the use of
derivatives. The Finance Committee defines what it considers to be
the optimal financial structure, determines the level of exposure of the Company
and keeps track of the financial derivatives contracted by the Company in the
Committee’s quarterly meetings. In addition, the Company has an external
auditor, which as part of its responsibilities audits the operating
effectiveness of the control activities in respect of the Company’s financial
derivatives positions.
ii)
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General
Description of Valuation Methods:
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The
Company values and records on its balance sheet derivative financial instruments
and hedging activities, including certain derivative instruments embedded in
other contracts, as either an asset or liability measured at fair value,
considering quoted prices in recognized markets. If such instruments are not
traded in a formal market, fair value is determined by applying techniques based
upon technical models supported by sufficient, reliable and verifiable market
data, recognized by the financial sector.
The
Company designates its financial instruments as cash flow hedges at the
inception of the hedging relationship, when transactions meet all hedging
accounting requirements. For cash flow hedges, the effective portion of the
valuation is recognized temporarily in cumulative other comprehensive income
within stockholders’ equity and subsequently reclassified to current earnings at
the same time the hedged item is recognized. When derivative instruments do not
meet all of the accounting requirements for hedging purposes, the change in fair
value is immediately recognized in net income. For fair value hedges, changes in
fair value are recorded in the consolidated results in the period the change
occurs as well as the changes in the market value from the notional
amount.
The
Company identifies embedded derivatives that should be segregated from the host
contract for purposes of valuation and recognition, such as certain leases
denominated in US dollars. When an embedded derivative is identified and the
host contract has not been stated at fair value and there are adequate elements
for its valuation, the embedded derivative is segregated from the host contract,
stated at fair value and is either classified as trading or as a hedge. Changes
in the fair value of the embedded derivatives at the closing of each period are
recognized in current earnings.
iii)
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Management
Discussion of internal and external liquidity
sources:
|
The
Company currently has access to different short term financing options in the
bank market, with national and international institutions, which have allowed
the Company to fund its treasury requirements. The Company is rated with the
highest investment grade for a Mexican Corporate (AAA) granted by Fitch Ratings
and Standard & Poors, which we believe allows the Company to consider this
market as an option for available capital resources. Also, the
Company actively manages its operating cash flows, allowing flexibility in the
use of capital expenditures and other operating expenses.
Additionally,
the company has different options for long term funding, with the national and
international bank markets, including the ability to potentially access to the
international capital markets through potential bond issuances.
iv)
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Explanation
of Derivative Financial Instruments, Risks and Results (Amounts expressed
in millions of Mexican Pesos).
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The
Company uses interest rate swaps to manage the interest rate risk associated
with its borrowings, pursuant to which it pays amounts based on a fixed rate and
receives amounts based on a floating rate. These instruments are recognized in
the consolidated balance sheet at their estimated fair value and have been
designated as a cash flow hedge. The estimated fair value is based on quoted
market prices for the termination of the contract at the end of the period.
Changes in fair value are recorded in cumulative other comprehensive
income.
For the
three months ended September 30, 2008, the net effect of expired derivative
contracts is included in the consolidated results as an interest expense and
amounted to Ps. 100.
A certain
portion of the Company’s interest rate swaps does not meet the hedging criteria
for accounting purposes. Consequently changes in the estimated fair value of
ineffective portion were recorded in the consolidated results as part of the
integral result of financing. The notional amount of derivative contracts as of
September 30, 2008 was Ps. 1,600 and expires in 2012, generating an asset of Ps.
25. The net effect of expired derivative contracts for the three months ended
September 30, 2008 that do not meet the hedging criteria for accounting purposes
resulted in a gain of Ps. 25.
b)
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Forward Agreements to Purchase
Foreign Currency:
|
The
Company entered into forward agreements to reduce its exposure to the risk of
exchange rate fluctuations between the Mexican peso and other currencies. These
instruments are recognized at their estimated fair value which is determined
based on prevailing market exchange rates to end the contracts at the end of the
period. These forward agreements have been designated as a cash flow hedge,
therefore the changes in the fair value are recorded in cumulative other
comprehensive income. As of September 30, 2008, the Company has forward
contracts to buy foreign currencies with a notional amount of Ps. 2,589. These
contracts expire in 2009 and as of September 30, 2008 they have generated an
asset of Ps. 9.
During
the third quarter of 2008, the Company recorded a net gain on expired forward
contracts of Ps. 107 as part of foreign exchange gain.
As of
September 30, 2008, certain of the Company’s forward agreements to buy U.S.
dollars and other currencies did not meet the hedging criteria for accounting
purposes; consequently, changes in the fair value were recorded in the
consolidated results as part of the integral result of financing. The notional
amount of those forward agreements to purchase foreign currency maturing in 2009
is Ps. 1,724 and they generated a liability of Ps.118. The net effect of expired
contracts during the third quarter of 2008 that did not meet the hedging
criteria for accounting purposes resulted in a loss of Ps. 93 recorded in the
results.
The
Company enters into cross currency swaps to reduce its exposure to risks of
exchange rate and interest rate fluctuations associated with its borrowings
denominated in U.S. dollars and other foreign currencies. These instruments are
recognized in the consolidated balance sheet at their estimated fair value which
is estimated based on formal technical models with the exchange rate and
interest rate in the market at the end of the period. These cross currency swap
agreements have been designated as a cash flow hedge; therefore the changes in
the fair value were recorded as other comprehensive income. As of September 30,
2008, the Company has cross currency swap agreements outstanding with a notional
amount of Ps. 2,657, expiring in 2013 and generated a fair value asset of Ps.
70. The net effect of expired contracts for the three months ended as of
September 30, 2008 was included in interest expense and amounted to Ps.
37.
As of
September 30, 2008, certain cross currency swap instruments did not meet the
hedging criteria for accounting purposes; consequently changes in the estimated
fair value are recorded as a gain or loss in the market value on ineffective
portion of derivative financial instruments in the consolidated results as part
of the integral result of financing. Those contracts with a notional amount of
Ps. 1,840 expire in 2012 and generated an asset of Ps. 39 as of September 30,
2008. The expired contracts for the three months ended as of September 30, 2008
resulted in a loss of Ps. 166. All the effects where recorded in the
results.
Additionally,
the company has cross currency derivatives designated as a fair value hedge. As
of September 30, 2008, the notional amount of such contracts is Ps. 3,026 and
expire in 2017, generating an asset of Ps. 121. The changes in the
fair value of the derivative are recorded in the consolidated results as the net
effect of the primary position market value. The effect of expired contracts for
the three months ended September 30, 2008, included in interest expense amounted
to Ps. 12.
d)
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Commodity
Price Contracts:
|
The
Company enters into different commodity price contracts to reduce its exposure
to the fluctuation in the costs of certain raw material. The fair value is
estimated based on the market valuations for the termination of the contracts at
the date of closing of the period. These contracts hedge the flow of an expected
transaction, therefore the changes in the fair value are recorded in cumulative
other comprehensive income. The Company has commodity price contracts with
maturity dates ending in 2013, with a notional amount of Ps. 5,477 and had
recorded a fair value liability of Ps. 631. For the three months ended September
30, 2008, the net effect of expired commodity price contracts were gains of Ps.
42 and were recorded as part of operating income impacting the related raw
material cost.
As of
September, 30, 2008, certain commodity price contracts to reduce the exposure to
risk of certain raw material costs, did not meet the hedging criteria for
accounting purposes; consequently changes in the estimated fair value are
recorded as part of the market value gain (loss) on ineffective portion of
derivative financial instruments within the consolidated income statement. As of
the end of September 30, 2008, the net effect of those contracts was a gain of
Ps. 19.
e)
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Embedded
Derivative Financial Instruments:
|
The
Company has determined that its leasing contracts denominated in U.S. dollars
host embedded derivative financial instruments. The fair value is estimated
based on formal technical models using market quotation of the exchange rate for
the termination of the contract as of the date of the closing of the period.
Changes in the fair value were recorded in current earnings in the integral
result of financing as market value on derivative financial instruments. As of
third quarter 2008, the net effect of embedded derivative financial in the
results was a loss of Ps. 17.
v)
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Quantitative
Information
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Summary
of Financial Derivative Instruments as of September 30,
2008
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(Amounts
expressed in millions of nominal mexican pesos)
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Type
of derivative, value or contract
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Purpose
of Hedge or other purposes, such as negotiation
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Notional
Amount / Nominal Value (1)
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Value
of Underlying Asset / Variable of reference (2)
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Fair
Value (3)
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Maturities
per year (4)
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Collaterals
/ Lines of Credit/ Guarantees
|
|
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Actual
Quarter
|
Previous
Quarter
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Actual
Quarter
|
Previous
Quarter
|
|
|
Currencies
(FX)
|
Accounting
|
$2,588.8
|
$2,579.7
|
$2,645.8
|
$9.0
|
-$57.1
|
2009
|
N/A
|
Aluminum
Options
|
Accounting
|
$129.6
|
$122.4
|
$93.2
|
$7.2
|
$36.3
|
2009
|
N/A
|
Aluminum
Swaps
|
Accounting
|
$4,085.9
|
$4,531.6
|
$3,897.3
|
-$445.7
|
$188.6
|
2011
|
N/A
|
Natural
Gas Swap
|
Accounting
|
$696.8
|
$891.7
|
$564.4
|
-$194.9
|
$132.4
|
2013
|
N/A
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Interest
Rate Swap (IRS)
|
Accounting
|
$12,639.3
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$12,661.6
|
$12,288.1
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-$22.3
|
$351.2
|
2014
|
N/A
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Cross
Currency Swaps (CCS)
|
Accounting
|
$5,682.9
|
$5,492.4
|
$5,772.7
|
$190.5
|
-$89.9
|
2017
|
N/A
|
Sugar
Futures
|
Accounting
|
$564.2
|
$562.2
|
$499.4
|
$2.3
|
$65.1
|
2009
|
$32.3
|
|
|
|
|
|
|
|
|
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Currencies
(FX)
|
Non
accounting
|
$1,756.2
|
$1,843.3
|
N/A
|
-$87.2
|
N/A
|
2009
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N/A
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Currencies
(FX) closed to mature
|
Non
accounting
|
$1,841.9
|
$1,872.6
|
$1,866.2
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-$30.7
|
-$24.3
|
2009
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N/A
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Cross
Currency Swaps (CCS)
|
Non
accounting
|
$1,840.4
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$1,801.4
|
$1,710.9
|
$39.0
|
$129.5
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2012
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N/A
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Aluminum
Options
|
Non
accounting
|
-$1,946.5
|
-$1,932.9
|
-$1,847.5
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-$13.6
|
-$99.0
|
2011
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N/A
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Natural
Gas Options
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Non
accounting
|
-$115.5
|
-$114.1
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-$91.3
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-$1.4
|
-$24.2
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2009
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N/A
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Grain
Swaps
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Non
accounting
|
$671.2
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$808.5
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$695.7
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-$137.3
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-$24.5
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2010
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N/A
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Interest
Rate Swap (IRS)
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Non
accounting
|
$1,600.0
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$1,574.7
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N/A
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$25.3
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N/A
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2012
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N/A
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Embedded
Derivative
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Non
accounting
|
|
|
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$34.4
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$51.5
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2010
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N/A
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(1)
Notional Amount equals to units for strike price.
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(2)
Value of Underlying Assent equivalent to the notional amount plus the fair
value effect of the financial instrument.
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(3)
Fair Value is the gain or loss resulting of the derivate financial
instrument valuation for a given period of time.
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(4)
Maturities per year equivalent to last year of maturity of the derivative
financial
instrument.
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vi)
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Sensitivity
Analysis (Amounts expressed in millions of nominal Mexican Pesos, except
for exchange rate):
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The
sensitivity analysis only considers the ineffective portion of the Company hedge
structure. We assume movements in the direction opposite to our hedges, holding
all other variables constant.
The
following tables illustrate the sensitivity analysis for the instruments that do
not qualify as accounting hedges.
a)
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Commodity
Price Contracts
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Ineffective
Hedges
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Fair
Value as
Sep-30-08
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Scenarios
|
Underlying
Asset
|
10%
|
25%
|
50%
|
Aluminum
|
-13.6
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-18.5
|
-15.0
|
-9.4
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Price
Aluminum
|
Gas
|
-1.4
|
-0.9
|
-0.7
|
-0.5
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Price
Gas
|
Grains
|
-137.3
|
-188.1
|
-265.1
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-393.5
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Price
Grains
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Total
|
-152.3
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-207.5
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-280.9
|
-403.4
|
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The
scenarios assume a percentage decrease in the fair value, of the price at which
the derivative was contracted and do not reflect the impact against the average
price paid for the commodity as of September 30, 2008.
b)
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Cross
Currency swaps to convert debt in Pesos to
Dollars.
|
Market
Variable
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As
30-Sep-08
FX:10.79
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Probable
Scenario
FX:13.00
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Possible
Scenario
FX:13.50
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Stress
Scenario
FX:16.20
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Fair
Value
|
39.0
|
-336.4
|
-421.4
|
-880.4
|
Income
Statement Effect (1)
|
|
-375.4
|
-460.4
|
-919.4
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(1) Includes
effect recorded as of September 30, 2008.
c)
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Forwards
to convert debt in Pesos to
Dollars.
|
Market
Variable
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As
Sep-30-08
FX:10.79
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Probable
Scenario
FX:13.00
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Possible
Scenario
FX:13.50
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Stress
Scenario
FX:16.20
|
Fair
Value
|
-117.9
|
-458.7
|
-535.9
|
-952.7
|
Income
Statement Effect (1)
|
|
-340.9
|
-418.0
|
-834.8
|
(1) Includes
effect recorded as of September 30, 2008.
d)
|
Swaps
of interest rates used to convert fixed rate debt in Pesos to variable
rate debt in Pesos.
|
Market
Variable
|
As
Sep-30-08
5YTIIE:
8.65%
|
Probable
Scenario
5YTIIE:
9.00%
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Possible
Scenario
5YTIIE:
10.85%
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Stress
Scenario
5YTIIE:
13.00%
|
Fair
Value
|
25.4
|
8.9
|
-77.8
|
-178.7
|
Income
Statement Effect (1)
|
|
-16.4
|
-103.2
|
-204.0
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(1) Includes
effect recorded as of September 30, 2008.
The
Company considers that for its position in derivate hedging instruments, the
effectiveness analyses are significantly robust and demonstrate the elimination
of risk in potential variations in the fluctuation in the market level of its
primary positions.
.
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FEMSA
is the leading beverage company in Latin America. It controls an integrated
beverage platform that comprises Coca-Cola FEMSA, the largest Coca-Cola bottler
in the region; FEMSA Cerveza, one of the leading brewers in Mexico, with
presence in Brazil, and an important beer exporter to the United States and
other countries; and Oxxo, the largest and fastest growing convenience store
chain in Mexico with over 6,000 stores.