Fair value measurement

To estimate the fair value of our financial assets and liabilities, we use valuation approaches within a hierarchy that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing an asset or liability based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the inputs that market participants would use in pricing an asset or liability and are developed based on the best information available in the circumstances. The fair value hierarchy is divided into three levels based on the source of inputs as follows:



Level 1	—	Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access
Level 2	—	Valuations for which all significant inputs are observable, either directly or indirectly, other than level 1 inputs
Level 3	—	Valuations based on inputs that are unobservable and significant to the overall fair value measurement

The availability of observable inputs can vary among the various types of financial assets and liabilities. To the extent that the valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. In certain cases, the inputs used for measuring fair value may fall into different levels of the fair value hierarchy. In such cases, for financial statement disclosure purposes, the level in the fair value hierarchy within which the fair value measurement is categorized is based on the lowest level of input used that is significant to the overall fair value measurement.

The fair values of each major class of the Company’s financial assets and liabilities measured at fair value on a recurring basis were as follows (in millions):



	Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)

Fair value measurement as of June 30, 2017, using:							Total
Assets:
Available-for-sale investments:
U.S. Treasury securities	$	7,661	$	—	$	—	$	7,661
Other government-related debt securities:
U.S.	—		226		—		226
Foreign and other	—		2,353		—		2,353
Corporate debt securities:
Financial	—		9,637		—		9,637
Industrial	—		9,569		—		9,569
Other	—		1,235		—		1,235
Residential mortgage-backed securities	—		1,682		—		1,682
Other mortgage- and asset-backed securities	—		1,853		—		1,853
Money market mutual funds	2,165		—		—		2,165
Other short-term interest-bearing securities	—		2,382		—		2,382
Equity securities	159		—		—		159
Derivatives:
Foreign currency contracts	—		18		—		18
Cross-currency swap contracts	—		153		—		153
Interest rate swap contracts	—		52		—		52
Total assets	$	9,985	$	29,160	$	—	$	39,145

Liabilities:
Derivatives:
Foreign currency contracts	$	—	$	93	$	—	$	93
Cross-currency swap contracts	—		398		—		398
Contingent consideration obligations in connection with business combinations	—		—		182		182
Total liabilities	$	—	$	491	$	182	$	673



	Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)

Fair value measurement as of December 31, 2016, using:							Total
Assets:
Available-for-sale investments:
U.S. Treasury securities	$	6,614	$	—	$	—	$	6,614
Other government-related debt securities:
U.S.	—		299		—		299
Foreign and other	—		1,759		—		1,759
Corporate debt securities:
Financial	—		8,460		—		8,460
Industrial	—		8,789		—		8,789
Other	—		1,077		—		1,077
Residential mortgage-backed securities	—		1,940		—		1,940
Other mortgage- and asset-backed securities	—		1,719		—		1,719
Money market mutual funds	2,782		—		—		2,782
Other short-term interest-bearing securities	—		4,188		—		4,188
Equity securities	154		—		—		154
Derivatives:
Foreign currency contracts	—		203		—		203
Interest rate swap contracts	—		41		—		41
Total assets	$	9,550	$	28,475	$	—	$	38,025

Liabilities:
Derivatives:
Foreign currency contracts	$	—	$	4	$	—	$	4
Cross-currency swap contracts	—		523		—		523
Interest rate swap contracts	—		7		—		7
Contingent consideration obligations in connection with business combinations	—		—		179		179
Total liabilities	$	—	$	534	$	179	$	713

The fair values of our U.S. Treasury securities, money market mutual funds and equity securities are based on quoted market prices in active markets with no valuation adjustment.

Most of our other government-related and corporate debt securities are investment grade with maturity dates of five years or less from the balance sheet date. Our other government-related debt securities portfolio is composed of securities with weighted-average credit ratings of A- or equivalent by Moody’s Investors Service, Inc. (Moody’s), and BBB+ or equivalent by Standard & Poor’s Financial Services LLC (S&P) or Fitch Ratings Inc. (Fitch); and our corporate debt securities portfolio has a weighted-average credit rating of A- or equivalent by Fitch, and BBB + or equivalent by S&P or Moody’s. We estimate the fair values of these securities by taking into consideration valuations obtained from third-party pricing services. The pricing services utilize industry standard valuation models, including both income- and market-based approaches, for which all significant inputs are observable, either directly or indirectly, to estimate fair value. The inputs include reported trades of and broker/dealer quotes on the same or similar securities; issuer credit spreads; benchmark securities; and other observable inputs.

Our residential mortgage-, other mortgage- and asset-backed securities portfolio is composed entirely of senior tranches, with credit ratings of AAA by S&P, Moody’s or Fitch. We estimate the fair values of these securities by taking into consideration valuations obtained from third-party pricing services. The pricing services utilize industry standard valuation models, including both income- and market-based approaches, for which all significant inputs are observable, either directly or indirectly, to estimate fair value. The inputs include reported trades of and broker/dealer quotes on the same or similar securities; issuer credit spreads; benchmark securities; prepayment/default projections based on historical data; and other observable inputs.

We value our other short-term interest-bearing securities at amortized cost, which approximates fair value given their near-term maturity dates.

All of our foreign currency forward and option derivatives contracts have maturities of three years or less, and all are with counterparties that have minimum credit ratings of A- or equivalent by S&P or Moody’s. We estimate the fair values of these contracts by taking into consideration valuations obtained from a third-party valuation service that utilizes an income-based industry standard valuation model for which all significant inputs are observable, either directly or indirectly. The inputs include foreign currency exchange rates, London Interbank Offered Rates (LIBOR), swap rates and obligor credit default swap rates. In addition, inputs for our foreign currency option contracts include implied volatility measures. The inputs, when applicable, are at commonly quoted intervals. See Note 12, Derivative instruments.

Our cross-currency swap contracts are with counterparties that have minimum credit ratings of A- or equivalent by S&P or Moody’s. We estimate the fair values of these contracts by taking into consideration valuations obtained from a third-party valuation service that utilizes an income-based industry standard valuation model for which all significant inputs are observable either directly or indirectly. The inputs include foreign currency exchange rates, LIBOR, swap rates, obligor credit default swap rates and cross-currency basis swap spreads. See Note 12, Derivative instruments.

Our interest rate swap contracts are with counterparties that have minimum credit ratings of A- or equivalent by S&P or Moody’s. We estimate the fair values of these contracts by using an income-based industry standard valuation model for which all significant inputs were observable either directly or indirectly. The inputs included LIBOR, swap rates and obligor credit default swap rates.

Contingent consideration obligations

As a result of our business acquisitions, we incurred contingent consideration obligations, as discussed below. The contingent consideration obligations are recorded at their estimated fair values by using probability-adjusted discounted cash flows, and we revalue the obligations each reporting period until the related contingencies have been resolved. The fair value measurements of these obligations are based on significant unobservable inputs related to product candidates acquired in business combinations and are reviewed quarterly by management in our R&D and commercial sales organizations. The inputs include, as applicable, estimated probabilities and timing of achieving specified regulatory and commercial milestones and estimated annual sales. Significant changes that increase or decrease the probabilities of achieving the related regulatory and commercial events, that shorten or lengthen the time required to achieve such events, or that increase or decrease estimated annual sales would result in corresponding increases or decreases in the fair values of the obligations, as applicable. Changes in the fair values of contingent consideration obligations are recognized in Other operating expenses in the Condensed Consolidated Statements of Income.

Changes in the carrying amounts of contingent consideration obligations were as follows (in millions):



	Three months ended June 30,						Six months ended June 30,
	2017			2016			2017		2016
Beginning balance	$	184		$	194		$	179	$	188
Net changes in valuation	(2		)	(23		)	3		(17		)
Ending balance	$	182		$	171		$	182	$	171

As a result of our acquisition of Dezima in October 2015, we are obligated to pay its former shareholders up to $1.25 billion of additional consideration contingent upon achieving certain development and sales-related milestones and low single-digit royalties on net product sales above a certain threshold. The estimated fair values of the contingent consideration obligations had an aggregate value of $110 million at acquisition. The valuation of the contingent consideration reflects delayed development of AMG 899 pending competitor clinical trials. Detailed information from these trials is expected in the third quarter of 2017 and may have a material impact on the value of the Dezima contingent consideration.

As a result of our acquisition of BioVex Group, Inc. in 2011, we are obligated to pay its former shareholders up to $325 million of additional consideration contingent upon the achievement of certain sales thresholds related to IMLYGIC^®(talimogene laherparepvec) within specified periods of time.

During the six months ended June 30, 2017 and 2016, there were no transfers of assets or liabilities between fair value measurement levels, and there were no material remeasurements of the fair values of assets and liabilities that are not measured at fair value on a recurring basis.

Summary of the fair values of other financial instruments

Cash equivalents

The estimated fair values of cash equivalents approximate their carrying values due to the short-term nature of such financial instruments.

Borrowings

We estimated the fair value of our borrowings (Level 2) by taking into consideration indicative prices obtained from a third-party financial institution that utilizes industry standard valuation models, including both income- and market-based approaches, for which all significant inputs are observable either directly or indirectly. These inputs include reported trades of and broker/dealer quotes on the same or similar securities; credit spreads; benchmark yields; foreign currency exchange rates, as applicable; and other observable inputs. As of June 30, 2017, and December 31, 2016, the aggregate fair values of our borrowings were $37.9 billion and $36.5 billion, respectively, and the carrying values were $35.1 billion and $34.6 billion, respectively.