Note 8. Financial Instruments

Fair Value of Derivative Instruments:

Derivative instruments were recorded at fair value in the condensed consolidated balance sheets as follows:


	As of September 30, 2016				As of December 31, 2015
	Asset		Liability		Asset		Liability
	Derivatives		Derivatives		Derivatives		Derivatives
	(in millions)

Derivatives designated as accounting hedges:
Currency exchange contracts	$	4	$	8	$	20	$	7
Commodity contracts		38		16		37		35
Interest rate contracts		10		16		12		57

	$	52	$	40	$	69	$	99


Derivatives not designated as accounting hedges:
Currency exchange contracts	$	14	$	57	$	61	$	33
Commodity contracts		52		47		70		56
Interest rate contracts		29		20		43		28

	$	95	$	124	$	174	$	117

Total fair value	$	147	$	164	$	243	$	216

During the first nine months of 2016 and 2015, derivatives designated as accounting hedges include cash flow and fair value hedges and derivatives not designated as accounting hedges include economic hedges. Non-U.S. dollar denominated debt designated as a hedge of our net investments in non-U.S. operations is not reflected in the table above, but is included in long-term debt summarized in Note 7, Debt and Borrowing Arrangements. We record derivative assets and liabilities on a gross basis in our condensed consolidated balance sheet. The fair value of our asset derivatives is recorded within other current assets and the fair value of our liability derivatives is recorded within other current liabilities.

The fair values (asset / (liability)) of our derivative instruments were determined using:


	As of September 30, 2016
				Quoted Prices in
				Active Markets		Significant			Significant
	Total			for Identical		Other Observable			Unobservable
	Fair Value of Net			Assets		Inputs			Inputs
	Asset / (Liability)			(Level 1)		(Level 2)			(Level 3)
	(in millions)

Currency exchange contracts	$	(47	)	$	–	$	(47	)	$	–
Commodity contracts		27			17		10			–
Interest rate contracts		3			–		3			–

Total derivatives	$	(17	)	$	17	$	(34	)	$	–


	As of December 31, 2015
				Quoted Prices in
				Active Markets		Significant			Significant
	Total			for Identical		Other Observable			Unobservable
	Fair Value of Net			Assets		Inputs			Inputs
	Asset / (Liability)			(Level 1)		(Level 2)			(Level 3)
	(in millions)

Currency exchange contracts	$	41		$	–	$	41		$	–
Commodity contracts		16			29		(13	)		–
Interest rate contracts		(30	)		–		(30	)		–

Total derivatives	$	27		$	29	$	(2	)	$	–

Level 1 financial assets and liabilities consist of exchange-traded commodity futures and listed options. The fair value of these instruments is determined based on quoted market prices on commodity exchanges. Our exchange-traded derivatives are generally subject to master netting arrangements that permit net settlement of transactions with the same counterparty when certain criteria are met, such as in the event of default. We also are required to maintain cash margin accounts in connection with funding the settlement of our open positions, and the margin requirements generally fluctuate daily based on market conditions. We have recorded margin deposits related to our exchange-traded derivatives of $16 million as of September 30, 2016 and margin deposits of $22 million as of December 31, 2015 within other current assets. Based on our net asset or liability positions with individual counterparties, in the event of default and immediate net settlement of all of our open positions, for derivatives we have in a net asset position, our counterparties would owe us a total of $32 million as of September 30, 2016 and $52 million as of December 31, 2015. For derivatives we have in a net liability position, we would owe less than $1 million as of September 30, 2016. As of December 31, 2015, there were no Level 1 derivatives in a net liability position.

Level 2 financial assets and liabilities consist primarily of over-the-counter (“OTC”) currency exchange forwards, options and swaps; commodity forwards and options; and interest rate swaps. Our currency exchange contracts are valued using an income approach based on observable market forward rates less the contract rate multiplied by the notional amount. Commodity derivatives are valued using an income approach based on the observable market commodity index prices less the contract rate multiplied by the notional amount or based on pricing models that rely on market observable inputs such as commodity prices. Our calculation of the fair value of interest rate swaps is derived from a discounted cash flow analysis based on the terms of the contract and the observable market interest rate curve. Our calculation of the fair value of financial instruments takes into consideration the risk of nonperformance, including counterparty credit risk. Our OTC derivative transactions are governed by International Swap Dealers Association agreements and other standard industry contracts. Under these agreements, we do not post nor require collateral from our counterparties. The majority of our commodity and currency exchange OTC derivatives do not have a legal right of set-off. In connection with our OTC derivatives that could be net-settled in the event of default, assuming all parties were to fail to comply with the terms of the agreements, for derivatives we have in a net liability position, we would owe $36 million as of September 30, 2016 and $101 million as of December 31, 2015, and for derivatives we have in a net asset position, our counterparties would owe us a total of $54 million as of September 30, 2016 and $64 million as of December 31, 2015. We manage the credit risk in connection with these and all our derivatives by entering into transactions with counterparties with investment grade credit ratings, limiting the amount of exposure with each counterparty and monitoring the financial condition of our counterparties.

Derivative Volume:

The net notional values of our derivative instruments were:


	Notional Amount
	As of September 30,		As of December 31,
	2016		2015
	(in millions)

Currency exchange contracts:
Intercompany loans and forecasted interest payments	$	3,211	$	4,148
Forecasted transactions		1,318		1,094
Commodity contracts		654		732
Interest rate contracts		2,050		3,033
Net investment hedge – euro notes		5,280		4,345
Net investment hedge – pound sterling notes		1,236		1,404
Net investment hedge – Swiss franc notes		1,518		1,073

Cash Flow Hedges:

Cash flow hedge activity, net of taxes, within accumulated other comprehensive earnings / (losses) included:


	For the Three Months Ended						For the Nine Months Ended
	September 30,						September 30,
	2016			2015			2016			2015
	(in millions)
Accumulated gain / (loss) at beginning of period	$	(36	)	$	(53	)	$	(45	)	$	(2	)
Transfer of realized losses / (gains) in fair value to earnings		(2	)		60			64			6
Unrealized gain / (loss) in fair value		4			(69	)		(53	)		(66	)

Accumulated gain / (loss) at end of period	$	(34	)	$	(62	)	$	(34	)	$	(62	)


After-tax gains / (losses) reclassified from accumulated other comprehensive earnings / (losses) into net earnings were:
	For the Three Months Ended						For the Nine Months Ended
	September 30,						September 30,
	2016			2015			2016			2015
	(in millions)
Currency exchange contracts – forecasted transactions	$	(6	)	$	(11	)	$	(3	)	$	73
Commodity contracts		8			(49	)		(1	)		(53	)
Interest rate contracts		–			–			(60	)		(26	)

Total	$	2		$	(60	)	$	(64	)	$	(6	)


After-tax gains / (losses) recognized in other comprehensive earnings / (losses) were:
	For the Three Months Ended						For the Nine Months Ended
	September 30,						September 30,
	2016			2015			2016			2015
	(in millions)
Currency exchange contracts – forecasted transactions	$	(11	)	$	8		$	(21	)	$	33
Commodity contracts		10			(38	)		19			(61	)
Interest rate contracts		5			(39	)		(51	)		(38	)

Total	$	4		$	(69	)	$	(53	)	$	(66	)

Cash flow hedge ineffectiveness was not material for all periods presented.

Within interest and other expense, net, we recorded pre-tax losses of $97 million in the first quarter of 2016 and $34 million in the first quarter of 2015 related to amounts excluded from effectiveness testing. These amounts relate to interest rate swaps no longer designated as cash flow hedges due to changes in financing plans. Due to lower overall costs and our decision to hedge a greater portion of our net investments in operations that use currencies other than the U.S. dollar as their functional currencies, our plans to issue U.S. dollar-denominated debt changed and we instead issued euro and Swiss franc-denominated notes in the current year first quarter, and euro, British pound sterling and Swiss franc-denominated notes in the prior-year first quarter. Amounts excluded from effectiveness testing were not material for the third quarter of 2016 and 2015.

We record pre-tax and after-tax (i) gains or losses reclassified from accumulated other comprehensive earnings / (losses) into earnings, (ii) gains or losses on ineffectiveness and (iii) gains or losses on amounts excluded from effectiveness testing in:

•

cost of sales for commodity contracts;

•

cost of sales for currency exchange contracts related to forecasted transactions; and

•

interest and other expense, net for interest rate contracts and currency exchange contracts related to intercompany loans.

Based on current market conditions, we would expect to transfer unrealized gains of $11 million (net of taxes) for commodity cash flow hedges, unrealized losses of $11 million (net of taxes) for currency cash flow hedges and unrealized losses of less than $1 million (net of taxes) for interest rate cash flow hedges to earnings during the next 12 months.

Hedge Coverage:

As of September 30, 2016, we hedged transactions forecasted to impact cash flows over the following periods:

•

commodity transactions for periods not exceeding the next 15 months;

•

interest rate transactions for periods not exceeding the next 7 years and 2 months; and

•

currency exchange transactions for periods not exceeding the next 15 months.

Fair Value Hedges:

Pre-tax gains / (losses) due to changes in fair value of our interest rate swaps and related hedged long-term debt were recorded in interest and other expense, net:


	For the Three Months Ended						For the Nine Months Ended
	September 30,						September 30,
	2016			2015			2016			2015
	(in millions)

Derivatives	$	(11	)	$	4		$	(2	)	$	8
Borrowings		11			(4	)		2			(8	)

Fair value hedge ineffectiveness and amounts excluded from effectiveness testing were not material for all periods presented. Economic Hedges: Pre-tax gains / (losses) recorded in net earnings for economic hedges were:
													Location of
	For the Three Months Ended						For the Nine Months Ended						Gain / (Loss)
	September 30,						September 30,						Recognized
	2016			2015			2016			2015			in Earnings
	(in millions)

Currency exchange contracts:
Intercompany loans and forecasted interest payments	$	7		$	8		$	18		$	22			Interest and other expense, net
Forecasted transactions		(14	)		43			(91	)		33			Cost of sales
Forecasted transactions		2			36			10			437			Interest and other expense, net
Forecasted transactions		4			5			16			(11	)		Selling, general and administrative expenses
Interest rate contracts		–			–			–			–			Interest and other expense, net
Commodity contracts		(13	)		(99	)		(26	)		(158	)		Cost of sales

Total	$	(14	)	$	(7	)	$	(73	)	$	323

In connection with the JDE coffee business transactions, we entered into a number of consecutive euro to U.S. dollar currency exchange forward contracts in 2015 to lock in an equivalent expected value in U.S. dollars. The mark-to-market gains and losses on the derivatives were recorded in earnings. We recorded net gains of $29 million for the three months and $436 million for the nine months ended September 30, 2015 within interest and other expense, net in connection with the forward contracts and the transferring of proceeds to our subsidiaries where coffee net assets and shares were deconsolidated. The currency hedge and related gains and losses were recorded within interest and other expense, net. See Note 2, Divestitures and Acquisitions — JDE Coffee Business Transactions, for additional information. Hedges of Net Investments in International Operations: After-tax gains / (losses) related to hedges of net investments in international operations in the form of euro, pound sterling and Swiss franc-denominated debt were:
													Location of
	For the Three Months Ended						For the Nine Months Ended						Gain / (Loss)
	September 30,						September 30,						Recognized in
	2016			2015			2016			2015			AOCI
	(in millions)

Euro notes	$	(38	)	$	(8	)	$	(110	)	$	188			Currency
Pound sterling notes		21			30			107			17			Translation
Swiss franc notes		(4	)		18			(33	)		(13	)		Adjustment