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 March 31, 2017				As of December 31, 2016
	Asset		Liability		Asset		Liability
	Derivatives		Derivatives		Derivatives		Derivatives
	(in millions)

Derivatives designated as accounting hedges:
Currency exchange contracts	$	13	$	2	$	19	$	8
Commodity contracts		7		13		17		22
Interest rate contracts		103		24		108		19

	$	123	$	39	$	144	$	49


Derivatives not designated as accounting hedges:
Currency exchange contracts	$	32	$	53	$	29	$	43
Commodity contracts		26		145		112		167
Interest rate contracts		20		14		27		19

	$	78	$	212	$	168	$	229

Total fair value	$	201	$	251	$	312	$	278

During the first quarter of 2017 and 2016, 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 March 31, 2017
				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	$	(10	)	$	–		$	(10	)	$	–
Commodity contracts		(125	)		(120	)		(5	)		–
Interest rate contracts		85			–			85			–

Total derivatives	$	(50	)	$	(120	)	$	70		$	–


	As of December 31, 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	$	(3	)	$	–		$	(3	)	$	–
Commodity contracts		(60	)		(86	)		26			–
Interest rate contracts		97			–			97			–

Total derivatives	$	34		$	(86	)	$	120		$	–

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 $170 million as of March 31, 2017 and $133 million as of December 31, 2016 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 $49 million as of March 31, 2017 and $48 million as of December 31, 2016. For derivatives we have in a net liability position, we would owe $2 million as of December 31, 2016.

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 $47 million as of March 31, 2017 and $40 million as of December 31, 2016, and for derivatives we have in a net asset position, our counterparties would owe us a total of $127 million as of March 31, 2017 and $162 million as of December 31, 2016. 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 March 31,			As of December 31,
	2017			2016
	(in millions)

Currency exchange contracts:
Intercompany loans and forecasted interest payments	$	3,181		$	3,343
Forecasted transactions		1,655			1,452
Commodity contracts		1,144			837
Interest rate contracts		6,375			6,365
Net investment hedge – euro notes		3,563			4,012
Net investment hedge – pound sterling notes		426			419
Net investment hedge – Swiss franc notes		1,646			1,447
Cash Flow Hedges: Cash flow hedge activity, net of taxes, within accumulated other comprehensive earnings/(losses) included:
	For the Three Months Ended March 31,
	2017			2016
	(in millions)

Accumulated gain/(loss) at January 1	$	(121	)	$	(45	)
Transfer of realized losses/(gains) in fair value to earnings		7			58
Unrealized gain/(loss) in fair value		11			(66	)

Accumulated gain/(loss) at March 31	$	(103	)	$	(53	)


After-tax gains/(losses) reclassified from accumulated other comprehensive earnings/(losses) into net earnings were:

	For the Three Months Ended March 31,
	2017			2016
	(in millions)

Currency exchange contracts – forecasted transactions	$	–		$	5
Commodity contracts		(7	)		(3	)
Interest rate contracts		–			(60	)

Total	$	(7	)	$	(58	)


After-tax gains/(losses) recognized in other comprehensive earnings/(losses) were:

	For the Three Months Ended March 31,
	2017			2016
	(in millions)

Currency exchange contracts – forecasted transactions	$	(6	)	$	(12	)
Commodity contracts		(1	)		(5	)
Interest rate contracts		18			(49	)

Total	$	11		$	(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 related to amounts excluded from effectiveness testing. This amount relates 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, we changed our plans to issue U.S. dollar-denominated debt and instead issued euro and Swiss franc-denominated notes in the first quarter of 2016. Amounts excluded from effectiveness testing were not material for the first quarter of 2017.

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 losses of $24 million (net of taxes) for commodity cash flow hedges, unrealized gains of $10 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 March 31, 2017, we hedged transactions forecasted to impact cash flows over the following periods:

•

commodity transactions for periods not exceeding the next 9 months;

•

interest rate transactions for periods not exceeding the next 6 years and 7 months; and

•

currency exchange transactions for periods not exceeding the next 9 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 March 31,
	For the Three Months Ended March 31,
	2017			2016
	(in millions)
Derivatives	$	(4	)	$	5
Borrowings		4			(5	)

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:
	For the Three Months Ended March 31,						Location of Gain/(Loss) Recognized in Earnings
	2017			2016
	(in millions)
Currency exchange contracts:
Intercompany loans and forecasted interest payments	$	2		$	5			Interest and other expense, net
Forecasted transactions		(17	)		(31	)		Cost of sales
Forecasted transactions		(2	)		8			Interest and other expense, net
Forecasted transactions		(1	)		4			Selling, general and administrative expenses
Commodity contracts		(62	)		(44	)		Cost of sales

Total	$	(80	)	$	(58	)

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:


	For the Three Months Ended						Location of Gain/(Loss) Recognized in AOCI
	March 31,
	2017			2016
	(in millions)

Euro notes	$	(29	)	$	154		Currency
Pound sterling notes		(5	)		(23	)	Translation
Swiss franc notes		(15	)		43		Adjustment