UPS 2011 Annual Report Download - page 127

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
NOTE 15. DERIVATIVE INSTRUMENTS AND RISK MANAGEMENT
Risk Management Policies
We are exposed to market risk, primarily related to foreign exchange rates, commodity prices and interest
rates. These exposures are actively monitored by management. To manage the volatility relating to certain of
these exposures, we enter into a variety of derivative financial instruments. Our objective is to reduce, where it is
deemed appropriate to do so, fluctuations in earnings and cash flows associated with changes in foreign currency
rates, commodity prices and interest rates. It is our policy and practice to use derivative financial instruments
only to the extent necessary to manage exposures. As we use price sensitive instruments to hedge a certain
portion of our existing and anticipated transactions, we expect that any loss in value for those instruments
generally would be offset by increases in the value of those hedged transactions. We do not hold or issue
derivative financial instruments for trading or speculative purposes.
Credit Risk Management
The forward contracts, swaps and options discussed below contain an element of risk that the counterparties
may be unable to meet the terms of the agreements. However, we minimize such risk exposures for these
instruments by limiting the counterparties to banks and financial institutions that meet established credit
guidelines, and monitoring counterparty credit risk to prevent concentrations of credit risk with any single
counterparty.
We have agreements with substantially all of our active counterparties containing early termination rights
and/or bilateral collateral provisions whereby cash is required whenever the net fair value of derivatives
associated with those counterparties exceed specific thresholds. Events, such as a credit rating downgrade
(depending on the ultimate rating level) would typically require an increase in the amount of collateral required
of the counterparty and/or allow us to take additional protective measures such as early termination of trades. At
December 31, 2011, we held cash collateral of $55 million under these agreements.
In connection with the agreements described above, we could also be required to provide additional
collateral or terminate transactions with certain counterparties in the event of a downgrade of our debt rating. The
amount of additional collateral is a fixed incremental amount. At December 31, 2011 the aggregate fair value of
the instruments covered by these contractual features that were in a net liability position was $10 million. The
Company has never been required to post any collateral as a result of these contractual features.
We have not historically incurred, and do not expect to incur in the future, any losses as a result of
counterparty default.
Accounting Policy for Derivative Instruments
We recognize all derivative instruments as assets or liabilities in the consolidated balance sheets at fair
value. The accounting for changes in the fair value of a derivative instrument depends on whether it has been
designated and qualifies as part of a hedging relationship and, further, on the type of hedging relationship. For
those derivative instruments that are designated and qualify as hedging instruments, a company must designate
the derivative, based upon the exposure being hedged, as a cash flow hedge, a fair value hedge or a hedge of a net
investment in a foreign operation.
A cash flow hedge refers to hedging the exposure to variability in expected future cash flows that is
attributable to a particular risk. For derivative instruments that are designated and qualify as a cash flow hedge,
115