FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS

Financial instruments include cash and cash equivalents, marketable securities, accounts receivable and payable, debt instruments and derivatives.

Changes in exchange rates and interest rates create exposure to market risk. Certain derivative financial instruments are used when available on a cost-effective basis to hedge the underlying economic exposure. These instruments qualify as cash flow, net investment and fair value hedges upon meeting certain criteria, including effectiveness of offsetting hedged exposures. Changes in fair value of derivatives that do not qualify for hedge accounting are recognized in earnings as they occur. Derivative financial instruments are not used for trading purposes.

Financial instruments are subject to counterparty credit risk which is considered as part of the overall fair value measurement. Counterparty credit risk is monitored on an ongoing basis and mitigated by limiting amounts outstanding with any individual counterparty, utilizing conventional derivative financial instruments and only entering into agreements with counterparties that meet high credit quality standards. The consolidated financial statements would not be materially impacted if any counterparty failed to perform according to the terms of its agreement. Collateral is not required by any party whether derivatives are in an asset or liability position under the terms of the agreements.

Fair Value Measurements – The fair value of financial instruments are classified into one of the following categories:

Level 1 inputs utilize unadjusted quoted prices in active markets accessible at the measurement date for identical assets or liabilities. The fair value hierarchy provides the highest priority to Level 1 inputs.

Level 2 inputs utilize observable prices for similar instruments and quoted prices for identical or similar instruments in non-active markets. Additionally, certain corporate debt securities utilize a third-party matrix pricing model using significant inputs corroborated by market data for substantially the full term of the assets. Equity and fixed income funds are primarily invested in publicly traded securities valued at the respective net asset value of the underlying investments. Level 2 derivative instruments are valued using LIBOR yield curves, less credit valuation adjustments, and observable forward foreign exchange rates at the reporting date. Valuations of derivative contracts may fluctuate considerably from volatility in underlying foreign currencies and underlying interest rates driven by market conditions and the duration of the contract.

Level 3 unobservable inputs are used when little or no market data is available. There were no Level 3 financial assets or liabilities as of December 31, 2016 and 2015.

Financial assets and liabilities measured at fair value on a recurring basis are summarized below:



	December 31, 2016					December 31, 2015
Dollars in Millions	Level 1		Level 2			Level 1		Level 2
Cash and cash equivalents - Money market and other securities	$	—	$	3,532		$	—	$	1,825
Marketable securities:
Certificates of deposit	—		27			—		804
Commercial paper	—		750			—		—
Corporate debt securities	—		3,947			—		5,638
Equity funds	—		101			—		92
Fixed income funds	—		7			—		11
Derivative assets	—		75			—		96
Equity investments	24		—			60		—
Derivative liabilities	—		(30		)	—		(18		)

Available-for-sale Securities

The following table summarizes available-for-sale securities:



Dollars in Millions	Amortized Cost		Gross Unrealized Gain in Accumulated OCI		Gross Unrealized Loss in Accumulated OCI			Fair Value
Dollars in Millions	Amortized Cost		Gross Unrealized Gain in Accumulated OCI		Gross Unrealized Loss in Accumulated OCI			Fair Value
December 31, 2016
Certificates of deposit	$	27	$	—	$	—		$	27
Commercial paper	750		—		—			750
Corporate debt securities	3,945		10		(8		)	3,947
Equity investments	31		—		(7		)	24
Total	$	4,753	$	10	$	(15	)	$	4,748

December 31, 2015
Certificates of deposit	$	804	$	—	$	—		$	804
Corporate debt securities	5,646		15		(23		)	5,638
Equity investments	74		10		(24		)	60
Total	$	6,524	$	25	$	(47	)	$	6,502



Dollars in Millions	December 31, 2016		December 31, 2015
Current marketable securities^(a)	$	2,113	$	1,885
Non-current marketable securities^(b)	2,719		4,660
Other assets	24		60
Total	$	4,856	$	6,605


(a)	The fair value option for financial assets was elected for investments in equity and fixed income funds. The fair value of these investments were $108 million at December 31, 2016 and $103 million at December 31, 2015 and were included in current marketable securities. Changes in fair value were not significant.


(b)	All non-current marketable securities mature within five years as of December 31, 2016 and 2015.

Qualifying Hedges

The following summarizes the fair value of outstanding derivatives:



		December 31, 2016					December 31, 2015
Dollars in Millions	Balance Sheet Location	Notional		Fair Value			Notional		Fair Value
Derivatives designated as hedging instruments:
Interest rate swap contracts	Prepaid expenses and other	$	250	$	—		$	—	$	—
Interest rate swap contracts	Other assets	500		1			1,100		31
Interest rate swap contracts	Accrued liabilities	500		—			—		—
Interest rate swap contracts	Pension and other liabilities	255		(3		)	650		(1		)
Forward starting interest rate swap contracts	Prepaid expenses and other	500		8			—		—
Forward starting interest rate swap contracts	Other assets	—		—			500		15
Forward starting interest rate swap contracts	Accrued liabilities	250		(11		)	—		—
Forward starting interest rate swap contracts	Pension and other liabilities	—		—			250		(7		)
Foreign currency forward contracts	Prepaid expenses and other	967		66			1,016		50
Foreign currency forward contracts	Accrued liabilities	198		(9		)	342		(5		)

Derivatives not designated as hedging instruments:
Foreign currency forward contracts	Prepaid expenses and other	106		—			—		—
Foreign currency forward contracts	Accrued liabilities	291		(4		)	445		(5		)
Foreign currency forward contracts	Pension and other liabilities	69		(3		)	—		—

Cash Flow Hedges — Foreign currency forward contracts are used to hedge certain forecasted intercompany inventory purchase transactions and certain other foreign currency transactions. The effective portion of changes in fair value for contracts designated as cash flow hedges are temporarily reported in accumulated other comprehensive loss and included in earnings when the hedged item affects earnings. The net gains on foreign currency forward contracts are expected to be reclassified to net earnings (primarily included in cost of products sold) within the next two years. The notional amount of outstanding foreign currency forward contracts was primarily attributed to the euro ($617 million) and Japanese yen ($321 million) at December 31, 2016.

In 2015, BMS entered into $750 million of forward starting interest rate swap contracts maturing in March 2017 to hedge the variability of probable forecasted interest expense associated with potential future issuances of debt. The contracts are designated as cash flow hedges with the effective portion of fair value changes included in other comprehensive income.

The earnings impact related to discontinued cash flow hedges and hedge ineffectiveness was not significant during all periods presented. Cash flow hedge accounting is discontinued when the forecasted transaction is no longer probable of occurring within 60 days after the originally forecasted date or when the hedge is no longer effective. Assessments to determine whether derivatives designated as qualifying hedges are highly effective in offsetting changes in the cash flows of hedged items are performed at inception and on a quarterly basis.

Net Investment Hedges — Non-U.S. dollar borrowings of €950 million ($993 million) at December 31, 2016 are designated to hedge the foreign currency exposures of the net investment in certain foreign affiliates. These borrowings are designated as net investment hedges and recognized in long term debt. The effective portion of foreign exchange gains on the remeasurement of euro debt was $48 million, $80 million, and $79 million for 2016, 2015 and 2014, respectively, and were recorded in the foreign currency translation component of accumulated other comprehensive loss with the related offset in long-term debt.

Fair Value Hedges — Fixed-to-floating interest rate swap contracts are designated as fair value hedges used as an interest rate risk management strategy to create an appropriate balance of fixed and floating rate debt. The contracts and underlying debt for the hedged benchmark risk are recorded at fair value. The effective interest rate for the contracts is one-month LIBOR (0.70% as of December 31, 2016) plus an interest rate spread ranging from (0.1)% to 4.6%. When the underlying swap is terminated prior to maturity, the fair value basis adjustment to the underlying debt instrument is amortized as a reduction to interest expense over the remaining life of the debt.

The notional amount of fixed-to-floating interest rate swap contracts executed was $255 million in 2016 and $200 million in 2014. The notional amount of fixed-to-floating interest rate swap contracts terminated was $500 million in 2016, $147 million in 2015 and $426 million in 2014 generating proceeds of $43 million in 2016, $28 million in 2015 and $119 million in 2014 (including accrued interest). Additional contracts were terminated in connection with debt redemptions in 2015 and 2014.

Debt Obligations

Short-term borrowings and the current portion of long-term debt includes:



	December 31,
Dollars in Millions	2016		2015
Bank drafts and short-term borrowings	$	243	$	139
Current portion of long-term debt	749		—
Total	$	992	$	139

The average amount of commercial paper outstanding was $254 million at a weighted-average interest rate of 0.16% during 2015. The maximum month end amount of commercial paper outstanding was $755 million with no outstanding borrowings at December 31, 2015. There were no commercial paper borrowings in 2016.

Long-term debt and the current portion of long-term debt includes:



	December 31,
Dollars in Millions	2016			2015
Principal Value:
0.875% Notes due 2017	$	750		$	750
1.750% Notes due 2019	500			500
2.000% Notes due 2022	750			750
7.150% Notes due 2023	302			302
3.250% Notes due 2023	500			500
1.000% Euro Notes due 2025	601			630
6.800% Notes due 2026	256			256
1.750% Euro Notes due 2035	601			630
5.875% Notes due 2036	404			404
6.125% Notes due 2038	278			278
3.250% Notes due 2042	500			500
4.500% Notes due 2044	500			500
6.880% Notes due 2097	260			260
0% - 5.75% Other - maturing 2017 - 2030	59			79
Subtotal	6,261			6,339

Adjustments to Principal Value:
Fair value of interest rate swap contracts	(2		)	30
Unamortized basis adjustment from swap terminations	287			272
Unamortized bond discounts and issuance costs	(81		)	(91		)
Total	$	6,465		$	6,550

Current portion of long-term debt	$	749		$	—
Long-term debt	5,716			6,550

The fair value of long-term debt was $6,932 million and $6,909 million at December 31, 2016 and 2015, respectively, and was estimated using Level 2 inputs which are based upon the quoted market prices for the same or similar debt instruments. The fair value of short-term borrowings approximates the carrying value due to the short maturities of the debt instruments.

Senior unsecured notes were issued in a registered public offerings in 2015. The notes rank equally in right of payment with all of BMS's existing and future senior unsecured indebtedness and are redeemable in whole or in part, at any time at a predetermined redemption price. BMS also terminated forward starting interest rate swap contracts entered into during 2015, resulting in an unrealized loss in other comprehensive income. The following table summarizes the issuance of long-term debt obligations in 2015 (none in 2016 and 2014):



	2015
Amounts in Millions	Euro			U.S. dollars
Principal Value:
1.000% Euro Notes due 2025	€	575		$	643
1.750% Euro Notes due 2035	575			643
Total	€	1,150		$	1,286

Proceeds net of discount and deferred loan issuance costs	€	1,133		$	1,268

Forward starting interest rate swap contracts terminated:
Notional amount	€	500		$	559
Unrealized loss	(16		)	(18		)

The following summarizes the debt redemption activity for 2015 and 2014 (none in 2016):



Dollars in Millions	2015		2014
Principal amount	$	1,624	$	582
Carrying value	1,795		633
Debt redemption price	1,957		676
Notional amount of interest rate swap contracts terminated	735		500
Interest rate swap termination payments	11		4
Loss on debt redemption^(a)	180		45


(a)	Including acceleration of debt issuance costs, loss on interest rate lock contract and other related fees.

Interest payments were $191 million in 2016, $205 million in 2015 and $238 million in 2014 net of amounts received from interest rate swap contracts.

We currently have two separate $1.5 billion revolving credit facilities from a syndicate of lenders. The facilities provide for customary terms and conditions with no financial covenants and were extended to October 2020 and July 2021. Each facility is extendable annually by one year on the anniversary date with the consent of the lenders. No borrowings were outstanding under either revolving credit facility at December 31, 2016 or 2015.

Available financial guarantees provided in the form of stand-by letters of credit and performance bonds were $812 million at December 31, 2016. Stand-by letters of credit are issued through financial institutions in support of guarantees for various obligations. Performance bonds are issued to support a range of ongoing operating activities, including sale of products to hospitals and foreign ministries of health, bonds for customs, duties and value added tax and guarantees related to miscellaneous legal actions. A significant majority of the outstanding financial guarantees will expire within the year and are not expected to be funded.