Derivative Instruments and Fair Value Measurement

We use foreign currency forward exchange contracts and foreign currency denominated debt obligations to manage certain foreign currency risks. We also use interest rate swap contracts to manage risks associated with interest rate fluctuations. The following information explains how we use and value these types of derivative instruments and how they impact our consolidated financial statements.

Additional information related to the impacts of cash flow hedges on other comprehensive income (loss) is included in Note 10.

Types of Derivative Instruments and Hedging Activities

Cash Flow Hedges

We enter into foreign currency forward exchange contracts to hedge our exposure to foreign currency exchange rate variability in the expected future cash flows associated with certain third-party and intercompany transactions denominated in foreign currencies forecasted to occur within the next two years (cash flow hedges). We report in other comprehensive income (loss) the effective portion of the gain or loss on derivative financial instruments that we designate and that qualify as cash flow hedges. We reclassify these gains or losses into earnings in the same periods when the hedged transactions affect earnings. To the extent forward exchange contracts designated as cash flow hedges are ineffective, changes in value are recorded in earnings through the maturity date. There was no impact on earnings due to ineffective cash flow hedges. At September 30, 2017, we had a U.S. dollar-equivalent gross notional amount of $741.2 million of foreign currency forward exchange contracts designated as cash flow hedges.

The pre-tax amount of (losses) gains recorded in other comprehensive income (loss) related to cash flow hedges that would have been recorded in the Consolidated Statement of Operations had they not been so designated was (in millions):



	2017			2016			2015
Forward exchange contracts	$	(16.1	)	$	(6.6	)	$	41.7

The pre-tax amount of gains (losses) reclassified from accumulated other comprehensive loss into the Consolidated Statement of Operations related to derivative forward exchange contracts designated as cash flow hedges, which offset the related gains and losses on the hedged items during the periods presented, was (in millions):



	2017			2016			2015
Sales	$	0.3		$	(5.5	)	$	(8.4	)
Cost of sales	(2.8		)	25.5			44.6
Selling, general and administrative expenses	(0.5		)	(0.9		)	—
Total	$	(3.0	)	$	19.1		$	36.2

Approximately $15.4 million of pre-tax net unrealized losses on cash flow hedges as of September 30, 2017 will be reclassified into earnings during the next 12 months. We expect that these net unrealized losses will be offset when the hedged items are recognized in earnings.

Net Investment Hedges

We use foreign currency forward exchange contracts and foreign currency denominated debt obligations to hedge portions of our net investments in non-U.S. subsidiaries (net investment hedges) against the effect of exchange rate fluctuations on the translation of foreign currency balances to the U.S. dollar. For all instruments that are designated as net investment hedges and meet effectiveness requirements, the net changes in value of the designated hedging instruments are recorded in accumulated other comprehensive loss within shareowners’ equity where they offset gains and losses recorded on our net investments globally. To the extent forward exchange contracts or foreign currency denominated debt designated as net investment hedges are ineffective, changes in value are recorded in earnings through the maturity date. There was no impact on earnings due to ineffective net investment hedges. At September 30, 2017, we had a gross notional amount of $677.3 million of foreign currency forward exchange contracts designated as net investment hedges.

The pre-tax amount of (losses) gains recorded in other comprehensive income (loss) related to net investment hedges that would have been recorded in the Consolidated Statement of Operations had they not been so designated was (in millions):



	2017			2016		2015
Forward exchange contracts	$	(16.3	)	$	2.3	$	(4.4	)
Foreign currency denominated debt	—			0.8		1.0
Total	$	(16.3	)	$	3.1	$	(3.4	)

Fair Value Hedges

We use interest rate swap contracts to manage the borrowing costs of certain long-term debt. In February 2015, we issued $600.0 million in aggregate principal amount of fixed rate notes. Upon issuance of these notes, we entered into fixed-to-floating interest rate swap contracts that effectively convert these notes from fixed rate debt to floating rate debt. We designate these contracts as fair value hedges because they hedge the changes in fair value of the fixed rate notes resulting from changes in interest rates. The changes in value of these fair value hedges are recorded as gains or losses in interest expense and are offset by the losses or gains on the underlying debt instruments, which are also recorded in interest expense. There was no impact on earnings due to ineffective fair value hedges. At September 30, 2017, the aggregate notional value of our interest rate swaps designated as fair value hedges was $600.0 million.

The pre-tax amount of net (losses) gains recognized within the Consolidated Statement of Operations related to derivative instruments designated as fair value hedges, which fully offset the related net gains and losses on the hedged debt instruments during the periods presented, was (in millions):



	2017			2016		2015
Interest expense	$	(24.1	)	$	14.1	$	5.4

Derivatives Not Designated as Hedging Instruments

Certain of our locations have assets and liabilities denominated in currencies other than their functional currencies resulting from intercompany loans and other transactions with third parties denominated in foreign currencies. We enter into foreign currency forward exchange contracts that we do not designate as hedging instruments to offset the transaction gains or losses associated with some of these assets and liabilities. Gains and losses on derivative financial instruments for which we do not elect hedge accounting are recognized in the Consolidated Statement of Operations in each period, based on the change in the fair value of the derivative financial instruments. At September 30, 2017, we had a U.S. dollar-equivalent gross notional amount of $224.9 million of foreign currency forward exchange contracts not designated as hedging instruments.

The pre-tax amount of (losses) gains from forward exchange contracts not designated as hedging instruments recognized in the Consolidated Statement of Operations was (in millions):



	2017			2016			2015
Cost of sales	$	(1.8	)	$	0.9		$	—
Other income (expense)	(8.6		)	(11.1		)	20.8
Total	$	(10.4	)	$	(10.2	)	$	20.8

Fair Value of Financial Instruments

U.S. GAAP defines fair value as the price that would be received for an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants in the principal or most advantageous market for the asset or liability. U.S. GAAP also classifies the inputs used to measure fair value into the following hierarchy:



Level 1:		Quoted prices in active markets for identical assets or liabilities.



Level 2:		Quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability.



Level 3:		Unobservable inputs for the asset or liability.

Derivative Instruments

We recognize all derivative financial instruments as either assets or liabilities at fair value in the Consolidated Balance Sheet. We value our forward exchange contracts using a market approach. We use a valuation model based on inputs including forward and spot prices for currency and interest rate curves. We did not change our valuation techniques during fiscal 2017, 2016 or 2015. It is our policy to execute such instruments with major financial institutions that we believe to be creditworthy and not to enter into derivative financial instruments for speculative purposes. We diversify our foreign currency forward exchange contracts among counterparties to minimize exposure to any one of these entities. Our foreign currency forward exchange contracts are usually denominated in currencies of major industrial countries. The U.S. dollar-equivalent gross notional amount of our forward exchange contracts totaled $1,643.4 million at September 30, 2017. Currency pairs (buy/sell) comprising the most significant contract notional values were United States dollar (USD)/euro, USD/Swiss franc, USD/Canadian dollar and Swiss franc/euro.

We value interest rate swap contracts using a market approach based on observable market inputs including publicized swap curves.

The fair value of our derivatives and their location in our Consolidated Balance Sheet were (in millions):



		Fair Value (Level 2)
Derivatives Designated as Hedging Instruments	Balance Sheet Location	September 30, 2017			September 30, 2016
Forward exchange contracts	Other current assets	$	12.4		$	5.2
Forward exchange contracts	Other assets	0.3			0.6
Forward exchange contracts	Other current liabilities	(19.1		)	(11.7		)
Forward exchange contracts	Other liabilities	(5.1		)	(1.8		)
Interest rate swap contracts	Other assets	—			19.5
Interest rate swap contracts	Other liabilities	(4.6		)	—
Total		$	(16.1	)	$	11.8



		Fair Value (Level 2)
Derivatives Not Designated as Hedging Instruments	Balance Sheet Location	September 30, 2017			September 30, 2016
Forward exchange contracts	Other current assets	$	0.8		$	4.4
Forward exchange contracts	Other current liabilities	(12.2		)	(3.9		)
Total		$	(11.4	)	$	0.5

Investments

We recognize all available-for-sale investments at fair value in the Consolidated Balance Sheet. The valuation methodologies used for our investments measured at fair value are described as follows.

Certificates of deposit and time deposits — These investments are stated at cost, which approximates fair value.

Commercial paper — These investments are stated at amortized cost, which approximates fair value.

Corporate debt securities — Valued at either the yields currently available on comparable securities of issuers with similar credit ratings or valued under a discounted cash flow approach that maximizes observable inputs, such as current yields of similar instruments, but includes adjustments for certain risks that may not be observable such as credit and liquidity risks.

Government securities — Valued at the most recent closing price on the active market on which the individual securities are traded or, absent an active market, utilizing observable inputs such as closing prices in less frequently traded markets.

Asset-backed securities — Valued using a discounted cash flow approach that maximizes observable inputs, such as current yields of benchmark instruments, but includes adjustments for certain risks that may not be observable such as credit and liquidity risks.

The methods described above may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while we believe our valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date. We did not hold any Level 3 investments or have any transfers between levels of fair value measurements during the periods presented.

Fair values of our investments were (in millions):



	September 30, 2017
	Level 1		Level 2		Level 3		Total
Certificates of deposit and time deposits	$	—	$	1,005.3	$	—	$	1,005.3
Commercial paper	—		20.3		—		20.3
Corporate debt securities	—		199.4		—		199.4
Government securities	98.9		17.9		—		116.8
Asset-backed securities	—		45.8		—		45.8
Total	$	98.9	$	1,288.7	$	—	$	1,387.6



	September 30, 2016
	Level 1		Level 2		Level 3		Total
Certificates of deposit and time deposits	$	—	$	902.8	$	—	$	902.8
Commercial paper	—		—		—		—
Corporate debt securities	—		—		—		—
Government securities	—		—		—		—
Asset-backed securities	—		—		—		—
Total	$	—	$	902.8	$	—	$	902.8

Other Financial Instruments

We also hold financial instruments consisting of cash, short-term debt and long-term debt. The fair values of our cash and short-term debt approximate their carrying amounts as reported in our Consolidated Balance Sheet due to the short-term nature of these instruments.

We base the fair value of long-term debt upon quoted market prices for the same or similar issues. The fair value of long-term debt below considers the terms of the debt excluding the impact of derivative and hedging activity. The carrying amount of a portion of our long-term debt is impacted by fixed-to-floating interest rate swap contracts that are designated as fair value hedges.

The following table presents the carrying amounts and estimated fair values of financial instruments not measured at fair value in the Consolidated Balance Sheet (in millions):



	September 30, 2017
			Fair Value
	Carrying Amount		Total		Level 1		Level 2		Level 3
Cash and cash equivalents	$	1,410.9	$	1,410.9	$	1,299.4	$	111.5	$	—
Short-term debt	350.4		350.4		—		350.4		—
Current portion of long-term debt	250.0		251.6		—		251.6		—
Long-term debt	1,243.4		1,452.6		—		1,452.6		—



	September 30, 2016
			Fair Value
	Carrying Amount		Total		Level 1		Level 2		Level 3
Cash and cash equivalents	$	1,526.4	$	1,526.4	$	1,480.6	$	45.8	$	—
Short-term debt	448.6		448.6		—		448.6		—
Current portion of long-term debt	—		—		—		—		—
Long-term debt	1,516.3		1,780.5		—		1,780.5		—