Financial Instruments

Fair values of financial instruments are summarized as follows (in millions):



	June 30, 2018				September 30, 2017
	Carrying Value		Fair Value		Carrying Value		Fair Value
Cash and cash equivalents	$	100	$	100	$	88	$	88
Short-term debt	48		73		288		329
Long-term debt	728		782		750		859
Foreign exchange forward contracts (other assets)	—		—		—		—
Foreign exchange forward contracts (other liabilities)	—		—		3		3
Foreign currency option contracts (other assets)	1		1		3		3
Cross-currency Swap (other assets)	6		6		—		—

The following table reflects the offsetting of derivative assets and liabilities (in millions):



	June 30, 2018			September 30, 2017
	Gross Amounts Recognized	Gross Amounts Offset	Net Amounts Reported	Gross Amounts Recognized	Gross Amounts Offset	Net Amounts Reported
Derivative Assets
Foreign exchange forward contracts	—	—	—	—	—	—
Derivative Liabilities
Foreign exchange forward contracts	—	—	—	3	—	3

Fair Value

The current FASB guidance provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical instruments (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:


•	Level 1 inputs use quoted prices in active markets for identical instruments.


•	Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar instruments in active markets and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.


•	Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related instrument.

In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest priority level input that is significant to the valuation. The company's assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset or liability.

Fair value of financial instruments by the valuation hierarchy at June 30, 2018 is as follows (in millions):



	Level 1		Level 2		Level 3
Cash and cash equivalents	$	100	$	—	$	—
Short-term debt	—		71		2
Long-term debt	—		777		5
Foreign exchange forward contracts (other assets)	—		—		—
Foreign exchange forward contracts (other liabilities)	—		—		—
Foreign currency option contracts (other assets)	—		—		1
Cross-currency Swap (other assets)	—		6		—

Fair value of financial instruments by the valuation hierarchy at September 30, 2017 is as follows (in millions):



	Level 1		Level 2		Level 3
Cash and cash equivalents	$	88	$	—	$	—
Short-term debt	—		325		4
Long-term debt	—		851		8
Foreign exchange forward contracts (other assets)	—		—		—
Foreign exchange forward contracts (other liabilities)	—		3		—
Foreign currency option contracts (other assets)	—		—		3
Cross-currency Swap (other assets)	—		—		—

The tables below provide a reconciliation of changes in fair value of the Level 3 financial assets and liabilities measured at fair value in the condensed consolidated balance sheet for the three and nine months ended June 30, 2018 and 2017, respectively. No transfers of assets between any of the Levels occurred during these periods.



Three months ended June 30, 2018 (in millions)	Short-term foreign currency option contracts			Long-term foreign currency option contracts		Total
Fair Value as of March 31, 2018	$	1		$	—	$	1
Total unrealized gains (losses):
Included in other income	1			—		1
Included in cost of sales	—			—		—
Total realized gains (losses):
Included in other income	—			—		—
Included in cost of sales	—			—		—
Purchases, issuances, sales and settlements:
Purchases	—			—		—
Settlements	(1		)	—		(1		)
Transfer in and / or out of Level 3 ⁽¹⁾	—			—		—
Reclass between short-term and long-term	—			—		—
Fair Value as of June 30, 2018	$	1		$	—	$	1



Three months ended June 30, 2017 (in millions)	Short-term foreign currency option contracts (asset)			Long-term foreign currency option contracts (asset)			Total
Fair Value as of March 31, 2017	$	3		$	2		$	5
Total unrealized gains (losses):
Included in other income	—			—			—
Included in cost of sales	(1		)	—			(1		)
Total realized gains (losses):
Included in other income	—			—			—
Included in cost of sales	—			—			—
Purchases, issuances, sales and settlements:
Purchases	—			1			1
Settlements	(2		)	(1		)	(3		)
Transfer in and / or out of Level 3 ⁽¹⁾	—			—			—
Reclass between short-term and long-term	1			(1		)	—
Fair Value as of June 30, 2017	$	1		$	1		$	2



Nine months ended June 30, 2018 (in millions)	Short-term foreign currency option contracts			Long-term foreign currency option contracts			Total
Fair Value as of September 30, 2017	$	2		$	1		$	3
Total unrealized gains (losses):
Included in other income	1			—			1
Included in cost of sales	(1		)	(1		)	(2		)
Total realized gains (losses):
Included in other income	—			—			—
Included in cost of sales	—			—			—
Purchases, issuances, sales and settlements:
Purchases	—			—			—
Settlements	(1		)	—			(1		)
Transfer in and / or out of Level 3 ⁽¹⁾	—			—			—
Reclass between short-term and long-term	—			—			—
Fair Value as of June 30, 2018	$	1		$	—		$	1



Nine months ended June 30, 2017 (in millions)	Short-term foreign currency option contracts (asset)			Long-term foreign currency option contracts (asset)			Total
Fair Value as of September 30, 2016	$	—		$	2		$	2
Total unrealized gains (losses):
Included in other income	—			—			—
Included in cost of sales	—			2			2
Total realized gains (losses):
Included in other income	—			—			—
Included in cost of sales	—			—			—
Purchases, issuances, sales and settlements:
Purchases	—			1			1
Settlements	(2		)	(1		)	(3		)
Transfer in and / or out of Level 3 ⁽¹⁾	—			—			—
Reclass between short-term and long-term	3			(3		)	—
Fair Value as of June 30, 2017	$	1		$	1		$	2

⁽¹⁾Transfers as of the last day of the reporting period.

Cash and cash equivalents — All highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents. The carrying value approximates fair value because of the short maturity of these instruments. The company did not have any cash equivalents as of June 30, 2018 or September 30, 2017.

Short- and long-term debt — Fair values are based on transaction prices at public exchange for publicly traded debt. For debt instruments that are not publicly traded, fair values are based on interest rates that would be currently available to the company for issuance of similar types of debt instruments with similar terms and remaining maturities.

Foreign exchange forward contracts — The company uses foreign exchange forward purchase and sale contracts with terms of 18 months or less to hedge its exposure to changes in foreign currency exchange rates. The fair value of foreign exchange forward contracts is based on a model which incorporates observable inputs including quoted spot rates, forward exchange rates and discounted future expected cash flows utilizing market interest rates with similar quality and maturity characteristics. For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of changes in the fair value of the contracts is recorded in Accumulated Other Comprehensive Loss in the statement of shareholders’ equity and is recognized in operating income when the underlying forecasted transaction impacts earnings.

Foreign currency option contracts — The company uses option contracts to mitigate foreign exchange exposure on expected future Indian Rupee-denominated purchases. As of June 30, 2018 and September 30, 2017, the notional amount of the company's Indian rupee foreign exchange contracts outstanding was $201 million and $172 million, respectively. The company did not elect hedge accounting for these derivatives. Changes in fair value associated with these contracts are recorded in cost of sales in the consolidated statement of operations.

The company uses option contracts to mitigate the risk of volatility in the translation of euro earnings to U.S. dollars. As of June 30, 2018 and September 30, 2017, the notional amount of the company's euro option contracts outstanding was $14 million and $58 million, respectively. These option contracts did not qualify for a hedge accounting election. Changes in fair value associated with these contracts are recorded in the consolidated statement of operations in other income, net.

The company uses option contracts to mitigate the risk of volatility in the translation of Swedish krona to U.S. dollars. As of June 30, 2018 and September 30, 2017, the notional amount of the company's Swedish krona option contracts outstanding was $13 million and $71 million, respectively. These option contracts did not qualify for a hedge accounting election. Changes in fair value associated with these contracts are recorded in the consolidated statement of operations in other income, net.

The company uses option contracts to mitigate foreign exchange exposure on expected future South Korean won-denominated purchases. As of June 30, 2018 and September 30, 2017, there were no South Korean won foreign exchange option contracts outstanding. The company did not elect hedge accounting for these derivatives. Changes in fair value associated with these contracts are recorded in cost of sales in the consolidated statement of operations.

The company uses foreign currency option contracts to mitigate foreign currency exposure on expected future Brazilian real-denominated purchases. As of June 30, 2018, the notional amount of the company's Brazilian real foreign exchange contracts outstanding was $13 million. As of September 30, 2017, there were no Brazilian real foreign exchange option contracts outstanding. The company did not elect hedge accounting for these derivatives. Changes in fair value associated with these contracts are recorded in cost of sales in the consolidated statement of operations.

The fair value of foreign exchange option contracts is based on third-party proprietary models, which incorporate inputs at varying unobservable weights of quoted spot rates, market volatility, forward rates and time utilizing market instruments with similar quality and maturity characteristics.

Cross-currency swap contracts — The company uses cross-currency swap contracts to hedge a portion of its net investment in a foreign subsidiary against volatility in foreign exchange rates. These derivative instruments are designated and qualify as hedges of net investments in foreign operations using the spot method to assess effectiveness. Settlements and changes in fair values of the instruments are recognized in foreign currency translation adjustments, a component of other comprehensive income (loss) on the consolidated statement of comprehensive income (loss), to offset the changes in the values of the net investments being hedged. Any portion of net investment hedges that is determined to be ineffective is recorded in other expenses, net on the consolidated statements of operations.

In the third quarter of fiscal year 2018, the company entered into multiple cross-currency swaps with a combined notional amount of $225 million. As of June 30, 2018, the notional amount of the company's cross-currency swap contracts outstanding was $225 million. These swaps hedged a portion of the net investment in a certain European subsidiary against volatility in the EUR/USD foreign exchange rate. They mature in May 2021.

The fair value of cross-currency swap contracts is based on a model which incorporates observable inputs, including quoted spot rates, forward exchange rates and discounted future expected cash flows, utilizing market interest rates with similar quality and maturity characteristics.