UPS 2007 Annual Report Download - page 52

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pricing practices in December 2007. In October 2007, we received information requests from the European
Commission and the New Zealand Commerce Commission relating to investigations of freight forwarding
pricing practices. We are cooperating with these investigations.
Market Risk
We are exposed to market risk from changes in certain commodity prices, foreign currency exchange rates,
interest rates, and equity prices. All of these market risks arise in the normal course of business, as we do not
engage in speculative trading activities. In order to manage the risk arising from these exposures, we utilize a
variety of foreign exchange, interest rate, equity and commodity forward contracts, options, and swaps.
The following analysis provides quantitative information regarding our exposure to commodity price risk,
foreign currency exchange risk, interest rate risk, and equity price risk. We utilize valuation models to evaluate
the sensitivity of the fair value of financial instruments with exposure to market risk that assume instantaneous,
parallel shifts in exchange rates, interest rate yield curves, and commodity and equity prices. For options and
instruments with non-linear returns, models appropriate to the instrument are utilized to determine the impact of
market shifts. There are certain limitations inherent in the sensitivity analyses presented, primarily due to the
assumption that exchange rates change in a parallel fashion and that interest rates change instantaneously. In
addition, the analyses are unable to reflect the complex market reactions that normally would arise from the
market shifts modeled.
A discussion of our accounting policies for derivative instruments and further disclosures are provided in
Note 15 to the consolidated financial statements.
Commodity Price Risk
We are exposed to changes in the prices of refined fuels, principally jet-A, diesel, and unleaded gasoline.
Currently, the fuel surcharges that we apply to our domestic and international package and LTL services are the
primary means of reducing the risk of adverse fuel price changes. Additionally, we use a combination of options
contracts to provide partial protection from changing fuel and energy prices. The net fair value of such contracts
subject to price risk, excluding the underlying exposures, as of December 31, 2007 and 2006 was an asset
(liability) of $(179) and $10 million, respectively. The potential loss in the fair value of these derivative
contracts, assuming a hypothetical 10% adverse change in the underlying commodity price, would be
approximately $42 and $8 million at December 31, 2007 and 2006, respectively. This amount excludes the
offsetting impact of the price risk inherent in the physical purchase of the underlying commodities.
In the second quarter of 2006, we terminated several energy derivatives and received $229 million in cash.
These derivatives were designated as hedges of forecasted cash outflows for purchases of fuel products. As these
derivatives maintained their effectiveness and qualified for hedge accounting, the gains associated with these
hedges were recognized in income over the original term of the hedges through the end of 2007.
Foreign Currency Exchange Risk
We have foreign currency risks related to our revenue, operating expenses, and financing transactions in
currencies other than the local currencies in which we operate. We are exposed to currency risk from the
potential changes in functional currency values of our foreign currency-denominated assets, liabilities, and cash
flows. Our most significant foreign currency exposures relate to the Euro, the British Pound Sterling and the
Canadian Dollar. We use a combination of purchased and written options and forward contracts to hedge cash
flow currency exposures. These derivative instruments generally cover forecasted foreign currency exposures for
periods up to one year. As of December 31, 2007 and 2006, the net fair value of the hedging instruments
described above was an asset (liability) of $(42) and $30 million, respectively. The potential loss in fair value for
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