FedEx Exchange Risk the Majority of Fedex\'s

FedEx Exchange Risk

The majority of FedEx's transactions are in the U.S. dollar, but foreign exchange currency risk exists with the British Pound, Canadian dollar, Chinese Yuan, euro, Hong King Dollar, and the Japanese yen. During 2012 and 2011, foreign currency fluctuations positively impacted the operating income. At May 31, 2012, a uniform 10% strengthening in the value of the dollar relative to currencies in which transactions were denominated would result in a decrease in operating income of $75 million in 2013 (FedEx Annual Report 2012, 2012). This assumes each exchange rate changes in the same direction relative to the U.S. dollar.

Some of the foreign currencies are stronger than the dollar, creating more profits, and some of the currencies are weaker than the dollar, creating losses in revenues. If the overall currency mix is stronger than the dollar, there will be additional revenues. If the overall currency mix is weaker than the dollar, or the dollar strengthens causing more weakness in other currencies, then there can be loss of revenue. Where the dollar strengthened with a uniform 10% increase, it would show more weakening in other currencies and create a loss of revenue. In some respects, the different foreign exchange currencies can hedge against each other because some are stronger than the dollar and some are weaker. But the overall value of all the foreign exchange rate values would determine whether the company would make profits, break even with the U.S. dollar, or create losses.

Two main ways investors judge a firm's value is profitability and cash flow, which are important reasons to limit a firm's exposure to changes in exchange rates (Volkov). Managers use forward contracts, options, and money market transactions to hedge potential foreign exchange risk. Forward Contracts are agreements between two private parties to make an agreed upon rate sometime in the future, at an agreed upon time. They eliminate exchange rate risk and any additional profits that can be earned with favorable movement in exchange rates. With the forward contract, the manager would know upfront what the revenue would be from the contract because it is for a predetermined value. It is advantageous if foreign exchange movement moves in unfavorable directions, but disadvantageous if the foreign exchange movement moves in favorable directions because it could mean more profits that are lost with the forward contract.

Currency option hedging is a contract that gives the owner the right, not the obligation, to make either a purchase or sale at an agreed upon price until the contract expires. It creates a floor on potential profit without a ceiling and costs a fee. The currency option is a sense of security against unfavorable foreign exchange rates because the floor lets the manager know the very least profit that can be made. But, depending on how the foreign exchange rates go, it could create profits that are below what the fee costs. It may not yield as much as a forward contract.