Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency Exchange Risk
In the normal course of business, we are exposed to foreign currency exchange risk as we conduct business outside the U.S. in several currencies including the British Pound Sterling, Euro, Indian Rupee, and Philippine Peso. Changes in the exchange rates for such currencies into U.S. dollars can affect our revenues, earnings, and the carrying values of our assets and liabilities in our consolidated balance sheet, either positively or negatively.
To manage the exposures related to the effects of foreign exchange rate fluctuations, the we utilize derivative instruments (foreign currency forward contracts). The changes in fair value for these foreign currency forward contracts are initially reported as a component of AOCL and subsequently reclassified into operating expenses when the hedged exposure affects earnings.
A sensitivity analysis was performed based on the estimated fair value of all foreign currency forward contracts outstanding at August 31, 2020. If the U.S. dollar had been 10% weaker, the fair value of outstanding foreign currency forward contracts would have increased by $13.0 million, which would have had an immaterial impact on our Consolidated Balance Sheet. Such a change in fair value of our financial instruments would be substantially offset by changes in our expense base. If we had no hedges in place as of August 31, 2020, a hypothetical 10% weaker U.S. dollar against all foreign currencies from the quoted foreign currency exchange rates at August 31, 2020, with operating results held constant in local currencies, would result in a decrease in operating income by $35.4 million over the next 12 months. A hypothetical 10% weaker U.S. dollar against all foreign currencies at August 31, 2020 would have increased the fair value of total assets by $66.3 million and equity by $41.6 million.
Volatility in the British Pound Sterling exchange rate remains a possibility in the short term as the UK continues the transition resulting from its exit from the European Union. In the longer term, any impact from Brexit will depend on, in part, the outcome of tariff, regulatory, and other negotiations. Refer to Item 1A. Risk Factors of this Annual Report on Form 10-K for further discussion on Brexit.
Refer to Note 6, Derivative Instruments in the Notes to the Company’s Consolidated Financial Statements included in Item 8. of this Annual Report on Form 10-K for more information on our foreign currency exposures and our foreign currency forward contracts.
Interest Rate Risk
Cash and Cash Equivalents and Investments
The fair market value of our cash and cash equivalents and investments at August 31, 2020 was $605.2 million. Our cash and cash equivalents consist of demand deposits and money market funds with original maturities of three months or less and are reported at fair value. We are exposed to interest rate risk through fluctuations of interest rates on our investments. As we have a restrictive investment policy, our financial exposure to fluctuations in interest rates is expected to remain low. Refer to Note 3, Summary of Significant Accounting Policie s in the Notes to the Company’s Consolidated Financial Statements included in Item 8. of this Annual Report on Form 10-K for more information on our cash and cash equivalents and investments policies.
Debt
As of August 31, 2020, we had long term debt outstanding under the 2019 Revolving Credit Facility with a principal balance of $ 575.0 million. The debt bears interest on the outstanding principle at a rate equal to LIBOR plus a spread, using a debt leverage pricing grid. The variable rate of interest on our long-term debt can expose us to interest rate volatility due to changes in LIBOR. To mitigate this exposure, on March 5, 2020, we entered into an interest rate swap agreement with a notional amount of $ 287.5 million to hedge the variable interest rate obligation, effectively converting the floating interest rate to fixed for the hedged portion. Thus, we are only exposed to base interest rate risk on floating rate borrowings in excess of any amounts that are not hedged, or $ 287.5 million of our outstanding principal balance. Assuming all terms of our outstanding long-term debt remained the same, a hypothetical 25 basis point change (up or down) in the one-month LIBOR would result in a $0.7
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million change to our annual interest expense for the portion of the long-term debt not hedged by the interest rate swap agreement. Refer to Note 12, Debt in the Notes to the Company’s Consolidated Financial Statements included in Item 8. of this Annual Report on Form 10-K for additional information regarding our outstanding debt obligations.
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