UPS 2012 Annual Report Download - page 110

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
98
NOTE 14. 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, 2012, we held cash collateral of $59 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, 2012 the aggregate fair value of the instruments covered by these contractual features that
were in a net liability position was $129 million; however, we were not required to post any collateral with our counterparties as of
that date.
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, the effective portion of the gain or loss on the
derivative instrument is reported as a component of AOCI, and reclassified into earnings in the same period during which the
hedged transaction affects earnings. The remaining gain or loss on the derivative instrument in excess of the cumulative change in
the present value of future cash flows of the hedged item, or hedge components excluded from the assessment of effectiveness, are
recognized in the statements of consolidated income during the current period.
A fair value hedge refers to hedging the exposure to changes in the fair value of an existing asset or liability on the
consolidated balance sheets 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 statements of consolidated income 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 AOCI. The
remainder of the change in value of such instruments is recorded in earnings.