Market Risk Discussion

In the normal course of operations, the company is exposed to changes in financial and commodity market conditions due to its business transactions denominated in diverse foreign currencies and its ongoing manufacturing and funding activities. As a result, future earnings, cash flows and fair values of assets and liabilities are subject to uncertainty. The company has established policies, procedures and internal processes governing its management of uncertain market conditions, and uses both operational and financial market actions in its risk management activities, which include the use of derivative instruments. The company does not use derivative instruments for trading purposes. The company only enters into derivative contracts based on economic analysis of underlying exposures anticipating that adverse impacts on future earnings, cash flows and fair values due to fluctuations in foreign currency exchange rates, interest rates and commodity prices will be offset by the proceeds from and changes in fair value of the derivative instruments. The company does not hedge its exposure to market risks in a manner that completely eliminates the effects of changing market conditions on earnings, cash flows and fair values. In evaluating the effects of changes in foreign currency exchange rates, interest rate and commodity prices on the company's business operations, the risk management system uses sensitivity analysis as a primary analytical technique. The range of changes used for the purpose of this market risk discussion reflects the company's view of changes which are reasonably possible over a one-year period. Fair values are the present value of projected future cash flows based on market rates and prices chosen.

Short-term exposures to changing foreign currency exchange rates are primarily due to operating cash flows denominated in foreign currencies. The company covers known and anticipated operating exposures by using purchased foreign currency exchange option and forward contracts. The primary currencies for which the company has foreign currency exchange rate exposure are the German deutsche mark, Italian lira and Japanese yen. In response to the greater fluctuations in foreign currency exchange rates in recent periods, the company has increased the degree of risk management activities to minimize their impact on earnings in future periods.

The company conducted a sensitivity analysis on the fair value of its foreign currency hedge portfolio assuming an instantaneous 10% change in foreign currency exchange rates from their levels as of December 31, 1997, with all other variables held constant. A 10% appreciation of the U.S. dollar against foreign currencies would result in an increase of $9 million in the fair value of foreign currency exchange hedging contracts. A 10% depreciation of the U.S. dollar would result in a decrease of $6 million in the fair value of foreign currency exchange hedging contracts. The sensitivity in fair value of the foreign currency hedge portfolio represents changes in fair values estimated based on market conditions as of December 31, 1997 without reflecting the effects of underlying anticipated transactions. When those anticipated transactions are realized, actual effects of changing foreign currency exchange rates could have a material impact on earnings and cash flows in future periods.

Long-term exposures to foreign currency exchange rate risks are managed primarily through operational activities. The company manufactures its products in a number of locations around the world; hence, has a cost base in a number of different European and Asian currencies. This diverse base of local currency costs serves to partially counterbalance the earnings effect of potential changes in value of local currency denominated revenues.

The company is exposed to changes in interest rates primarily due to its borrowing and investing activities which include primarily short and long-term debt used to maintain liquidity and fund its business operations. The company's current strategic policy is to maintain from 20% to 40% of floating rate debt, with a long-term average of 30%. A 100 basis point move in interest rates would affect the value of the company's floating and fixed rate instruments, including short and long-term debt and derivative instruments, but would not have a material impact on earnings and changes in their fair values would not have a material adverse effect on the company's financial position. 100 basis points approximate 10% of the company's weighted average rate on its worldwide debt.

The company purchases certain raw materials such as natural gas, propylene, acetone, and butanol under short and long-term supply contracts. The purchase prices are generally determined based on prevailing market conditions. The company uses commodity derivative instruments to modify some of the commodity price risks. Assuming a 10% change in the underlying commodity price, the potential change in the fair value of commodity derivative contracts held at December 31, 1997 would not be material when compared with the company's earnings and financial position.

This market risk discussion and the estimated amounts presented are forward-looking statements that assume certain market conditions. Actual results in the future may differ materially from these projected results due to developments in relevant financial markets, including Asia. The methods used above to assess risk should not be considered projections of expected future events or results.

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