Note 2. Investments

The investment objective of the Plan is to earn an average rate of return that exceeds its long-term funding target by employing appropriate asset mix policies and risk diversification strategies. The nominal long-term return target of the Plan during the year was 6.75 percent.

a) Summary of Investments

The following schedule summarizes the fair value and cost of the Plan’s investments before allocating the market exposure related to derivative financial instruments, as at December 31:

($ Millions)	2007						2006
	Fair Value			Cost			Fair Value			Cost
Fixed income
Cash and short-term securities	$	508		$	506		$	$639		$	639
Bonds
Canadian		32,258			31,819			23,358			22,853
Non-Canadian		10,183			10,904			6,602			6,383
		42,949			43,229			30,599			29,875
Equity
Canadian		767			964			441			560
Non-Canadian		3,845			3,632			5,933			4,937
		4,612			4,596			6,374			5,497
Equity-Oriented
Real estate		3,878			2,774			3,371			2,575
Private equity and special situations		1,222			1,338			1,041			1,165
		5,100			4,112			4,412			3,740
Total Investments	$	52,661		$	51,937		$	41,385		$	39,112
Investment related receivables
Receivables from derivative financial instruments [note 2cii]		1,566			-			892			-
Securities purchased under resell agreements		348			348			-			-
Pending trades		184			183			354			353
Accrued investment income		413			413			325			325
		2,511			944			1,571			678
Investment related liabilities
Obligations related to securities sold short		(16,056)			(14,018)			(12,872)			(10,480)
Liabilities from derivative financial instruments [note 2cii]		(1,326)			(2)			(649)			31
Real estate mortgages		(817)			(817)			(779)			(765)
Securities sold under repurchase agreements		(6,600)			(6,600)			(613)			(613)
Pending trades		(525)			(524)			(264)			(263)
Obligations related to securities lending		-			-			(7)			(7)
Accrued liabilities		(55)			(55)			(40)			(40)
		(25,379)			(22,016)			(15,224)			(12,137)
Net Investments	$	29,793		$	30,865		$	27,732		$	27,653

b) Risk Management

Fundamental to the risk management process is the understanding of risks associated with all areas of the Plan’s business and its operating environment, and the articulation of strategies for dealing with those risks.

The Plan’s investment portfolio is subject to risks that could adversely affect its cash flows, net assets available for benefits, and income.

The Plan controls investment – related risks through its Statement of Investment Policies and Procedures (SIP&P) and Investment Policies and Guidelines (IP&G), which prescribe a long-term debt-equity asset mix policy; require portfolio investment diversification; set guidelines on investment categories; and limit exposure to individual investments, major asset classes, geographic markets and currency. Derivatives are utilized to manage credit and market exposures.

Interest Rate Risk

Interest rate risk is the risk that the market value of the Plan’s investments will fluctuate due to changes in market interest rates. It arises from the potential variation in the timing and amount of cash flows related to the Plan’s assets and liabilities.

The value of the Plan’s investments and investment related receivables and liabilities are affected by short-term changes in nominal interest rates and equity markets. Pension liabilities are influenced by expectations of long-term inflation and salary escalation, as well as long-term rates of return on investments.

Guidelines on the weighting and duration for the fixed income portfolio and related derivative positions are set and monitored to manage the Plan’s interest rate risk.

The remaining terms to contractual maturity or repricing dates, whichever dates are earlier, of interest-bearing investments (including those which back derivative instruments) as at December 31 are as follows:

($ Millions, except %)		2007														2006
Interest-Bearing Instruments		Within 1 Year			1 to 5 Years			Over 5 Years				Total		Effective Yield		Total			Effective Yield
Short-term securities		$	435			–			–		$	435		5.59%		$	527		3.97%
Canadian bonds*
Federal bonds			51		$	3,312		$	3,765			7,128		4.26%			4,225		4.21%
Provincial and municipal bonds			2,060			5,962			5,284			13,306		3.75%			9,235		3.61%
Real return bonds			–			–			1,685			1,685		1.48%			1,304		1.36%
Corporate bonds			2,529			6,253			1,209			9,991		5.17%			8,594		4.48%
			4,640			15,527			11,943			32,110		4.19%			23,358		3.92%
Non-Canadian bonds			2,006			6,133			2,044			10,183		5.35%			6,602		5.22%
		$	7,081		$	21,660		$	13,987		$	42,728		4.48%		$	30,487		4.20%

* Net of Canadian bonds sold short of $148 million [2006: $nil]

Currency Risk

Currency risk is the risk that the value of the Plan’s investments will fluctuate due to changes in foreign exchange rates. The Investment Policies and Guidelines require that the Plan’s foreign currency exposure on equity and equity-oriented investments be approximately 50% hedged, fixed income investments be 100% hedged and currency exposures on derivative positions be hedged. This is accomplished by entering into foreign currency forward contracts or swaps for the purchase or sale of foreign currencies.

The Plan’s investments by currency of risk including related derivative financial instruments, as at December 31, are as follows:

(Canadian dollar, Millions)	2007									2006
Currency	Currency Exposure			Net Foreign Hedge			Net Exposure			Net Exposure
Canada	$	14,762		$	11,641		$	26,403		$	23,526
United States		11,534			(10,077)			1,457			2,115
Euro		1,723			(1,050)			673			580
Other European		742			(203)			539			612
Japanese		463			(217)			246			335
Other Pacific		235			(94)			141			194
Emerging Markets		334			(0)			334			370
	$	29,793		$	–		$	29,793		$	27,732

Credit Risk

Credit risk is the risk that a loss could arise from a securities issuer being unable to meet its financial obligations. Credit risk is mitigated by adherence to investment policy limits on credit ratings and exposure to individual corporate entities and derivative counterparties. The Plan may have fixed income exposure to below investment grade issues arising from credit rating downgrades, which may be hedged by utilizing credit default swaps from financial institutions rated A and higher. Management may also enter into credit default swap arrangements where no credit rating downgrades have occurred.

Market Risk

Market risk is the risk that the value of an investment will fluctuate as a result of changes in market prices, whether those changes are caused by factors specific to the individual investment or its issuer or factors affecting all securities traded in the market. The Plan enters into short positions, where it agrees to sell securities which it does not already own. The risk associated with short positions is that the Plan could be required to purchase the securities at a market price which exceeds the agreed upon sale price. The Plan’s policy is to invest in a diversified portfolio of investments, based on criteria established in the investment policy, and to utilize derivative financial instruments to mitigate the impact of market risk.

Securities Lending and Collateral Received

To enhance the portfolio return, the Plan lends securities to approved borrowers. Credit risk associated with the securities lending program is mitigated by requiring the borrower to provide daily securities collateral with market values exceeding the market value of the loaned securities. The securities lending program also includes transactions with cash as collateral. The cash is reinvested in short-term money market securities and expected to earn a rate of return in excess of the net rebate paid to the securities borrower. As at December 31, the fair value of loaned securities was $378 million (2006: $598 million). Collateral received associated with securities lending totaled $407 million (2006: $629 million) comprised of securities worth $407 million (2006: $622 million) and cash of $nil (2006: $7 million).

Securities Borrowing and Collateral Lodged

The Plan borrows securities from financial institutions for securities that have been sold short for yield enhancement strategies. Fixed income securities deposited or pledged with various financial institutions as collateral or margin totaled $16,881 million (2006: $13,778 million) for securities borrowing, $385 million (2006: $340 million) for futures, $750 million (2006: $2,328 million) for other derivative obligations, and $32 million (2006: $nil) for repurchase agreements.

c) Derivative Financial Instruments

Derivatives are financial contracts, the value of which is derived from the value of underlying assets, interest rates, indices, or exchange rates.

The Plan’s investment objectives for the use of derivatives are to enhance returns by facilitating changes in the investment asset mix to enhance equity and fixed income portfolio returns, and to manage financial risk. Derivatives are only permitted if their value is based on some component of equities, bonds, or money market instruments, and not on any other asset class.

i) Derivative Product Types

Foreign exchange forward contracts

A foreign exchange forward contract is a customized agreement negotiated between two parties to buy or sell a specific amount of a foreign currency at a price specified at origination of the contract, with settlement at a specified future date. Forward contracts are used to modify the Plan’s exposure to currency risk.

Foreign exchange, equity and bond options

An option contract is a contractual agreement under which the seller grants the purchaser the right, but not the obligation, either to buy (call option) or sell (put option) at or until a specified future date a specified amount of a particular financial instrument at a predetermined price. The seller receives a premium from the purchaser for this right. Options are bought and sold to manage the exposures of market risk to a particular financial instrument without directly purchasing or selling the underlying security.

Caps and floors

An interest rate cap is a series of call options on the specified reference interest rate. The buyer receives payment at maturity if the reference interest rate is above the agreed strike rate. An interest rate floor is a series of put options on the specified reference interest rate. The buyer receives payment at maturity if the reference interest rate is below the agreed strike rate.

Equity swaps

An equity swap is a contractual agreement between two parties to exchange a series of cash flows based on the return of an equity or an equity index return. One party typically agrees to pay a floating interest rate in return for receiving the equity return. Equity swaps are used for yield enhancement purposes and also to adjust exposures to particular indices without directly purchasing or selling the securities which comprise the index.

Interest rate swaps

An interest rate swap (including cross currency swap) is a contractual agreement between two parties to exchange a series of fixed or floating cash flows in the same currency or different currencies based on the notional amount. Interest rate swaps are used to manage interest rate exposures and cross currency swaps are used to manage both interest rate and currency exposures.

Credit default swaps

A credit default swap is a contractual agreement between two parties where the buyer of the protection pays a premium to the seller in exchange for payment of the notional amount from the seller against delivery of the related/relevant debt securities if a credit event such as a default occurs. Instead of physical settlement, credit default swaps can also be cash settled. Credit default swaps are bought and sold to promote credit diversification and for risk mitigation.

Variance swaps

A variance swap is a contractual agreement to exchange cash flows based on the difference in volatility of two underlying rates, such as exchange rates, interest rates or stock indices.

Bond and equity futures contracts

Futures contracts involve an agreement to buy or sell a standardized amount of bonds or equity indices, at a predetermined future date and price, in accordance with terms specified by a regulated futures exchange and are subject to daily cash margining. These types of derivatives are used to efficiently modify exposures without actually purchasing or selling the underlying assets.

ii) Derivative Related Credit Risk

Credit risk is the risk of loss in the event the counterparty to a transaction defaults, or otherwise fails to perform under the terms of a contract. Credit risk exposure for derivative financial instruments is measured by the positive fair value of the contractual obligations with the counterparties, less any collateral or margin received, as at the reporting date. To manage this risk, contracts can only be transacted on a regulated exchange or with counterparties with a minimum credit rating of A, as determined by a recognized credit rating agency. In addition, the Plan utilizes an internal credit-limit monitoring process and has master netting arrangements (which provide for certain rights of offset) in place and the right to obtain collateral. For futures contracts, credit risk exposure is negligible, as the contracts are transacted over an exchange as opposed to with an individual counterparty. All derivative contracts currently held by HOOPP have daily, quarterly or semi-annual resets.

The following schedule summarizes the notional, fair value and credit exposure of the Plan’s derivatives position, as at December 31:

($ Millions)		2007
		Notional Value*						Fair Value						Credit Risk
Derivative Financial Instruments		Long			Short			Assets			Liabilities			Exposure
Foreign exchange forward contracts		$	4,939		$	4,939		$	41		$	(51)		$	41
Options
Foreign exchange			125			125			1			-			1
Caps and floors			50						-			-			-
Equity			363			366			503			(444)			503
Bond			-			-			-			-			-
Swaps
Equity			19,624			2,507			168			(430)			168
Interest rate			12,984			2,685			724			(297)			724
Credit default			6,287			6,363			128			(91)			128
Variance			28			26			1			(8)			1
Futures contracts
Equity			7,163			3,803			-			(5)			-
TOTAL		$	51,563		$	20,814		$	1,566		$	(1,326)		$	1,566

($ Millions)		2006
		Notional Value*						Fair Value						Credit Risk
Derivative Financial Instruments		Long			Short			Assets			Liabilities			Exposure
Foreign exchange forward contracts		$	3,243		$	3,243		$	16		$	(79)		$	16
Options
Foreign exchange			51			51			-			(3)			-
Caps and floors			50			-			-			-			-
Equity			28			27			16			(46)			16
Bond			-			-			-			-			-
Swaps
Equity			14,327			900			681			(9)			681
Interest rate			13,486			2,501			134			(410)			134
Credit default			6,000			3,799			42			(87)			42
Variance			11			9			3			(2)			3
Futures contracts
Equity			7,796			643			-			(13)			-
TOTAL		$	44,992		$	11,173		$	892		$	(649)		$	892

* Notional values represent the contractual amounts to which a rate or price is applied for computing the cash flows to be exchanged, and are therefore not recorded as assets or liabilities in these consolidated financial statements. Notional amounts do not represent the level of financial risk, nor the potential gain or loss arising from these instruments.

The following schedule provides the notional values for the Plan’s derivative positions by term to maturity:

($ Millions)		2007
		Within 1 year						1 to 5 years						Over 5 years
Derivative Financial Instruments by Term to Maturity (Notional Values)		Long			Short			Long			Short			Long			Short
Foreign exchange forward contracts		$	4,939		$	4,939		$	-		$	-		$	-		$	-
Options
Foreign exchange			125			125			-			-			-			-
Caps and floors			-			-			50			-			-			-
Equity			362			365			1			2			-			-
Bond			-			-			-			-			-			-
Swaps
Equity			19,624			2,506			-			-			-			-
Interest rate			3,718			562			7,781			1,734			1,485			390
Credit default			853			1,914			3,634			3,102			1,800			1,346
Variance			28			26			-			-			-			-
Futures contracts
Equity			7,163			3,803			-			-			-			-
TOTAL		$	36,812		$	14,240		$	11,466		$	4,838		$	3,285		$	1,736

($ Millions)		2006
		Within 1 year						1 to 5 years						Over 5 years
Derivative Financial Instruments by Term to Maturity (Notional Values)		Long			Short			Long			Short			Long			Short
Foreign exchange forward contracts		$	3,243		$	3,243		$	-		$	-		$	-		$	-
Options
Foreign exchange			51			51			-			-			-			-
Caps and floors			-			-			50			-			-