UPS 2010 Annual Report Download - page 118

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
A fair value hedge refers to hedging the exposure to changes in the fair value of an existing asset or liability
on the balance sheet that is attributable to a particular risk. For derivative instruments that are designated and
qualify as a fair value hedge, the gain or loss on the derivative instrument is recognized in the income statement
during the current period, as well as the offsetting gain or loss on the hedged item.
A net investment hedge refers to the use of cross currency swaps, forward contracts, or foreign currency
denominated debt to hedge portions of our net investments in foreign operations. For hedges that meet the
effectiveness requirements, the net gains or losses attributable to changes in spot exchange rates are recorded in
the cumulative translation adjustment within other AOCI. The remainder of the change in value of such
instruments is recorded in earnings.
Types of Hedges
Commodity Risk Management
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 on our business. We periodically enter into
option contracts on energy commodity products to manage the price risk associated with forecasted transactions
involving refined fuels, principally jet-A, diesel, and unleaded gasoline. The objective of the hedges is to reduce
the variability of cash flows, due to changing fuel prices, associated with the forecasted transactions involving
those products. We have designated and account for these contracts as cash flow hedges of the underlying
forecasted transactions involving these fuel products and, therefore, the resulting gains and losses from these
hedges are recognized as a component of fuel expense or revenue when the underlying transactions occur.
Foreign Currency Risk Management
To protect against the reduction in value of forecasted foreign currency cash flows from our international
package business, we maintain a foreign currency cash flow hedging program. Our most significant foreign
currency exposures relate to the Euro, the British Pound Sterling, and the Canadian Dollar. We hedge portions of
our forecasted revenue denominated in foreign currencies with option contracts. We have designated and account
for these contracts as cash flow hedges of anticipated foreign currency denominated revenue and, therefore, the
resulting gains and losses from these hedges are recognized as a component of international package revenue
when the underlying sales transactions occur.
We have foreign currency denominated debt obligations and capital lease obligations associated with our
aircraft. For some of these debt obligations and leases, we hedge the foreign currency denominated contractual
payments using cross-currency interest rate swaps, which effectively convert the foreign currency denominated
contractual payments into U.S. Dollar denominated payments. We have designated and account for these swaps
as cash flow hedges of the forecasted contractual payments and, therefore, the resulting gains and losses from
these hedges are recognized in the income statement when the currency remeasurement gains and losses on the
underlying debt obligations and leases are incurred.
Interest Rate Risk Management
Our indebtedness under our various financing arrangements creates interest rate risk. We use a combination
of derivative instruments, including interest rate swaps and cross-currency interest rate swaps, as part of our
program to manage the fixed and floating interest rate mix of our total debt portfolio and related overall cost of
borrowing. The notional amount, interest payment, and maturity dates of the swaps match the terms of the
associated debt being hedged. Interest rate swaps allow us to maintain a target range of floating rate debt within
our capital structure.
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