Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk and Risk Management
In the normal course of business, we have exposures to interest rate risk from our investments, credit facility, and foreign exchange rate risk related to our foreign operations and foreign currency transactions.
Interest Rate Risk
Our market risk exposure relates to changes in interest rates in our investment portfolio and credit facility. We generally place our investments with high-credit quality issuers and by policy are averse to principal loss and seek to protect and preserve our invested funds by limiting default risk, market risk, and reinvestment risk.
As of December 31, 2020, our investments consisted primarily of certificates of deposit with maturity of less than one year. As a measurement of the sensitivity of our portfolio and if our investment portfolio balances remain constant, a hypothetical decrease of 100 basis points (1%) in interest rates would decrease annual pre-tax earnings by a nominal amount.
As of December 31, 2020, we had $323.8 million of borrowings under our Credit Facility at a rate based on a reserve adjusted Eurodollar Rate or a Base Rate plus an applicable margin. Our quarterly commitments of interest payments are impacted by an increase or decrease of interest rate fluctuations.
In April 2020, the Company executed interest rate swap contracts with independent financial institutions to partially reduce the variability of cash flows in LIBOR indexed debt interest payments on our Term Loan Facility (under the Company’s existing Credit Agreement dated as of September 10, 2019). These transactions are accounted for as cash flow hedging instruments.
The interest rate swap contracts fixed 85% of the outstanding principal balance on our term loan to a total interest rate of 1.271%. This is comprised of 0.521% average fixed rate per annum in exchange for a variable interest rate based on one-month USD-LIBOR-BBA plus the credit spread in the Company’s existing Credit Agreement, which is 75 basis points at current leverage ratios.
If our $323.8 million in borrowings had been outstanding for the full year ended December 31, 2020, a hypothetical increase of 100 basis points (1%) in interest rates would increase our commitments by $3.2 million.
Foreign Currency Exchange Rate Risk
We are impacted by changes in foreign currency exchange rates through sales and purchasing transactions when we sell products and purchase materials in currencies different from the currency in which product and manufacturing costs were incurred. The functional currencies of our worldwide facilities primarily include the USD, EUR, KRW, TWD, ILS, GBP, and CNY. Our purchasing and sales activities are primarily denominated in the USD, JPY, EUR, and CNY. We may be impacted by changes in the relative buying power of our customers, which may impact sales volumes either positively or negatively. As these currencies fluctuate against each other, and other currencies, we are exposed to foreign currency exchange rate risk on sales, purchasing transactions and labor.
Acquisitions are a large component of our capital deployment strategy. A significant number of acquisition target opportunities are located outside the U.S. and their value may be denominated in foreign currency. Changes in exchange rates therefore may have a material impact on their valuation in USD and may impact our view of their attractiveness.
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From time to time, we may enter into foreign currency exchange rate contracts to hedge against changes in foreign currency exchange rates on assets and liabilities expected to be settled at a future date, including foreign currency, which may be required for a potential foreign acquisition. Market risk arises from the potential adverse effects on the value of derivative instruments that result from a change in foreign currency exchange rates. We may enter into foreign currency forward contracts to manage the exchange rate risk associated with intercompany debt denominated in nonfunctional currencies. We minimize our market risk applicable to foreign currency exchange rate contracts by establishing and monitoring parameters that limit the types and degree of our derivative contract instruments. We enter into derivative contract instruments for risk management purposes only. We do not enter into or issue derivatives for trading or speculative purposes.
Our reported financial results of operations, including the reported value of our assets and liabilities, are also impacted by changes in foreign currency exchange rates. Assets and liabilities of substantially all of our subsidiaries outside the U.S. are translated at period end rates of exchange for each reporting period. Operating results and cash flow statements are translated at weighted-average rates of exchange during each reporting period. Although these translation changes have no immediate cash impact, the translation changes may impact future borrowing capacity, and overall value of our net assets.
Currency exchange rates vary daily and often one currency strengthens against the USD while another currency weakens. Because of the complex interrelationship of the worldwide supply chains and distribution channels, it is difficult to quantify the impact of a change in one or more particular exchange rates.
Effect of currency translation on cash
The effect of foreign currency translations on cash had a $5.1 million favorable impact for the year ended December 31, 2020 compared to a $1.5 million unfavorable impact for the year ended December 31, 2019. Our foreign operations primarily sell product and incur expenses in the related local currency. Exchange rate fluctuations could require us to increase prices to foreign customers, which could result in lower net sales by us to such customers. Alternatively, if we do not adjust the prices for our products in response to unfavorable currency fluctuations, our results of operations could be adversely impacted. The functional currencies of our worldwide operations include U.S. dollar ("USD") and the currencies noted in the table below. Our purchasing and sales activities are primarily denominated in USD, CNY, EUR, and JPY.
The change in these key currency rates are as follows:
Years Ended December 31,
From
To
2020
2019
Canadian Dollar (CAD)
USD
2.2
%
4.7
%
Swiss Franc (CHF)
USD
9.6
%
1.7
%
Chinese Yuan (CNY)
USD
6.7
%
(1.3)
%
Danish Krone (DKK)
USD
9.8
%
(2.1)
%
Euro (EUR)
USD
9.4
%
(2.0)
%
Pound Sterling (GBP)
USD
3.5
%
3.5
%
Israeli New Shekel (ILS)
USD
7.6
%
8.5
%
India Rupee (INR)
USD
(2.4)
%
(2.5)
%
Japanese Yen (JPY)
USD
5.3
%
1.2
%
South Korean Won (KRW)
USD
6.3
%
(3.6)
%
Philippine Peso (PHP)
USD
5.6
%
3.5
%
Singapore Dollar (SGD)
USD
1.8
%
1.3
%
New Taiwan Dollar (TWD)
USD
6.7
%
N/A
%
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