Most business entities are exposed to a wide variety of market risks. These can include changes in the future costs of acquiring materials and supplies, changes in the market values of financial assets and liabilities, effects on future revenues and expenses of swings in foreign exchange rates, potential effects of defaults on accounts receivable from major customers, and many other risks. In some cases, managers insulate themselves from some of these risks by using risk management strategies. Detailed footnote disclosures are required in order to alert readers to various risks that a firm might have, and the actions (if any) that management is taking to insulate the firm from potential losses.
Exhibit 7.2 shows portions of such disclosures included in Delta Air Lines’1997 financial report. Many of the terms in the exhibit are probably not familiar to you, and detailed discussions of these items are beyond the scope of this book. Yet it is instructive to review the exhibit as a reminder that each firm faces a somewhat unique set of exposures that are not measured and reported in the body of the financial statements. Nonetheless, these risks can be quite important to analysts in assessing the credit-worthiness of the firm.
Exhibit 7.2 Off Balance-Sheet Risks
Delta Air Lines – Selected Portions of Footnotes to 1997 Financial Statements
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS: RISKS AND FAIR VALUES – FUEL PRICE RISK MANAGEMENT – Under its fuel hedging program, the Company can enter into certain contracts with counterparties, not to exceed one year in duration, to manage the Company’s exposure to jet fuel price volatility. Gains and losses from fuel hedging transactions are recognized as a component of fuel expense when the underlying fuel being hedged is used. Any premiums paid for entering hedging contracts are recorded as a prepaid expense and amortized to fuel expense over the respective contract periods. On June 30, 1997, Delta had contracted for approximately 441 million gallons of its projected fiscal 1998 fuel requirements. At June 30, 1997, the fair value of option contracts used for purchases of jet fuel at fixed average prices was immaterial. The Company will be exposed to fuel hedging transaction losses in the event of non-performance by counterparties, but management does not expect any counterparty to fail to meet its obligations.
FOREIGN EXCHANGE RISK MANAGEMENT – The Company has entered into certain foreign exchange forward contracts, all with maturities of less than two months, in order to manage risks associated with foreign currency exchange rate and interest rate volatility. The aggregate face amount of such contracts was approximately $29 million at June 30, 1997. Gains and losses resulting from foreign exchange forward contracts are recognized as a component of miscellaneous income (expense), offsetting the foreign currency gains and losses resulting from translation of the Company’s assets and liabilities denominated in foreign currencies.
CREDIT RISKS – To manage credit risk associated with its fuel price risk and foreign exchange risk management programs, the Company selects counterparties based on their credit ratings. It also limits its exposure to any one counterparty under defined guidelines and monitors the market position of the program and its relative market position with each counterparty.
CONCENTRATION OF CREDIT RISK – Delta’s accounts receivable are generated primarily from airline ticket and cargo services sales to individuals and various commercial enterprises that are economically and geographically dispersed, and the accounts receivable are generally short-term in duration. Accordingly, Delta does not believe it is subject to any significant concentration of credit risk.