Financial instruments include cash and cash equivalents, marketable securities, accounts receivable and payable, debt instruments and derivatives. Due to their short term maturity, the carrying amount of receivables and accounts payable approximate fair value. Cash equivalents primarily consist of highly liquid investments with original maturities of three months or less at the time of purchase and are recorded at cost, which approximates fair value.

The Company has exposure to market risk due to changes in currency exchange rates and interest rates. As a result, 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.

All financial instruments, including derivatives, 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 is 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. Under the terms of the agreements, posting of collateral is not required by any party whether derivatives are in an asset or liability position.

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

Level 1 inputs utilize quoted prices (unadjusted) in active markets that are accessible at the measurement date for identical assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs. These instruments include U.S. treasury bills and U.S. government agency securities.

Level 2 inputs include observable prices for similar instruments, quoted prices for identical or similar instruments in markets that are not active, and other observable inputs that can be corroborated by market data for substantially the full term of the assets or liabilities. These instruments include corporate debt securities, commercial paper, Federal Deposit Insurance Corporation (FDIC) insured debt securities, certificates of deposit, money market funds, foreign currency forward contracts and interest rate swap contracts. Level 2 derivative instruments are valued using LIBOR and EURIBOR yield curves, less credit valuation adjustments, and observable forward foreign exchange rates at the reporting date. Valuations of derivative contracts may fluctuate considerably from period-to-period due to volatility in underlying foreign currencies and underlying interest rates, which are driven by market conditions and the duration of the contract. Credit adjustment volatility may have a significant impact on the valuation of interest rate swaps due to changes in counterparty credit ratings and credit default swap spreads.

Level 3 unobservable inputs are used when little or no market data is available. Valuation models for the ARS and FRS portfolio are based on expected cash flow streams and collateral values including assessments of counterparty credit quality, default risk underlying the security, discount rates and overall capital market liquidity. The fair value of ARS was determined using internally developed valuations that were based in part on indicative bids received on the underlying assets of the securities and other evidence of fair value. A majority of the ARS, which are private placement securities with long-term nominal maturities, were rated 'A' by Standard and Poor's, and primarily represent interests in insurance securitizations. Due to the current lack of an active market for FRS and the general lack of transparency into their underlying assets, other qualitative analysis is relied upon to value FRS including discussions with brokers and fund managers, default risk underlying the security and overall capital markets liquidity.

The following table summarizes available-for-sale securities at September 30, 2011 and December 31, 2010:

					Unrealized		Unrealized
					Gain in		Loss in
			Amortized		Accumulated		Accumulated		Fair	Fair Value
Dollars in Millions			Cost		OCI		OCI		Value	Level 1		Level 2		Level 3
September 30, 2011
Marketable Securities:
	Certificates of Deposit	$	1,476	$	-	$	-	$	1,476	$	-	$	1,476	$	-
	Corporate Debt Securities		2,875		53		(3)		2,925		-		2,925		-
	Commercial Paper		1,322		-		-		1,322		-		1,322		-
	U.S. Treasury Bills		400		3		-		403		403		-		-
	FDIC Insured Debt Securities		302		2		-		304		-		304		-
	Auction Rate Securities (ARS)		80		12		-		92		-		-		92
	Floating Rate Securities (FRS)		21		-		(2)		19		-		-		19
	Total Marketable Securities	$	6,476	$	70	$	(5)	$	6,541	$	403	$	6,027	$	111

December 31, 2010
Marketable Securities:
	Certificates of Deposit	$	1,209	$	-	$	-	$	1,209	$	-	$	1,209	$	-
	Corporate Debt Securities		1,996		26		(10)		2,012		-		2,012		-
	Commercial Paper		482		-		-		482		-		482		-
	FDIC Insured Debt Securities		353		3		-		356		-		356		-
	U.S. Treasury Bills		400		4		-		404		404		-		-
	U.S. Government Agency Securities		375		1		-		376		376		-		-
	Auction Rate Securities (ARS)		80		11		-		91		-		-		91
	Floating Rate Securities (FRS)		21		-		(2)		19		-		-		19
	Total Marketable Securities	$	4,916	$	45	$	(12)	$	4,949	$	780	$	4,059	$	110

The following table summarizes the classification of available for sale securities in the consolidated balance sheet:

Money market funds and other securities aggregating $4,162 million and $4,332 million at September 30, 2011 and December 31, 2010, respectively, were included in cash and cash equivalents and valued using Level 2 inputs. At September 30, 2011, $2,727 million of non-current available for sale corporate debt securities, U.S. treasury bills, FDIC insured debt securities and floating rate securities mature within five years. All auction rate securities mature beyond 10 years.

Cash Flow Hedges − Foreign currency forward contracts are primarily utilized to hedge forecasted intercompany purchase transactions in certain foreign currencies. These forward contracts are designated as cash flow hedges with the effective portion of changes in fair value being temporarily reported in accumulated OCI and recognized in earnings when the hedged item affects earnings. The primary foreign currency exposures hedged are the Euro, Japanese yen, Canadian dollar, British pound, Australian dollar and Swiss franc. The net deferred gains on foreign currency forward contracts qualifying for cash flow hedge accounting are expected to be reclassified to cost of products sold within the next two years, including $13 million of pre-tax deferred gains to be reclassified within the next 12 months.

Cash flow hedge accounting is discontinued when the forecasted transaction is no longer probable of occurring on the originally forecasted date, or 60 days thereafter, 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. Any ineffective portion of the change in fair value is included in current period earnings. The earnings impact related to discontinued cash flow hedges and hedge ineffectiveness was not significant during the three and nine months ended September 30, 2011 and 2010.

Net Investment Hedges − Non-U.S. dollar borrowings of €541 million ($731 million) 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 or losses on the remeasurement of the debt is recognized in the foreign currency translation component of accumulated OCI with the related offset in long term debt.

Fair Value Hedges – Fixed-to-floating interest rate swap contracts are designated as fair value hedges and are used as part of an interest rate risk management strategy to create an appropriate balance of fixed and floating rate debt. The swaps and underlying debt for the benchmark risk being hedged are recorded at fair value. When the underlying swap is terminated prior to maturity, the fair value basis adjustment to the underlying debt instrument is amortized into earnings as a reduction to interest expense over the remaining life of the debt.

The adjustment to long-term debt from interest rate swaps that qualify as fair value hedges and other items was as follows:

		September 30,		December 31,
Dollars in Millions		2011		2010
Principal Value		$	4,715	$	4,749
Adjustments to Principal Value:
	Fair value of interest rate swaps		131		234
	Unamortized basis adjustment from swap terminations		614		369
	Unamortized bond discounts		(23)		(24)
Total Long-term debt		$	5,437	$	5,328

In September 2011, the Company replaced its $2.0 billion revolving credit facility with a new $1.5 billion five year revolving credit facility from a syndicate of lenders, which is extendable on any anniversary date with the consent of the lenders. There were no borrowings outstanding under either revolving credit facility at September 30, 2011 or December 31, 2010.

During the nine months ended September 30, 2011, $71 million aggregate principal value of the 5.875% Debentures due 2036 was repurchased for $78 million and $34 million notional amount of interest rate swaps related to the debt repurchase was terminated resulting in proceeds of $6 million. The corresponding gain related to these transactions was $10 million.

During the nine months ended September 30, 2011, fixed-to-floating interest rate swap agreements of $1.6 billion notional amount and €1.0 billion notional amount were terminated generating total proceeds of $356 million (including accrued interest of $66 million). During the nine months ended September 30, 2010, fixed-to-floating interest rate swap agreements of $237 million notional amount and €500 million notional amount were terminated generating total proceeds of $116 million (including accrued interest of $18 million).

Interest expense was $40 million and $38 million for the three months ended September 30, 2011 and 2010, respectively, and $103 million for both the nine months ended September 30, 2011 and 2010.

Non-Qualifying Foreign Exchange Contracts − Foreign currency forward contracts are used to offset exposure to foreign currency-denominated monetary assets, liabilities and earnings. The primary objective of these contracts is to protect the U.S. dollar value of foreign currency-denominated monetary assets, liabilities and earnings from the effects of volatility in foreign exchange rates that might occur prior to their receipt or settlement in U.S. dollars. These contracts are not designated as hedges and are adjusted to fair value through other (income)/expense as they occur, and substantially offset the change in fair value of the underlying foreign currency denominated monetary asset, liability or earnings. The effect of non-qualifying hedges on earnings was not significant for the three and nine months ended September 30, 2011 and 2010.

			September 30, 2011				December 31, 2010
					Fair Value				Fair Value
Dollars in Millions		Balance Sheet Location	Notional		(Level 2)		Notional		(Level 2)
Derivatives designated as hedging instruments:
	Interest rate contracts	Other assets	$	579	$	131	$	3,526	$	234
	Foreign currency forward contracts	Other assets		1,579		79		691		26
	Foreign currency forward contracts	Accrued expenses		588		(40)		732		(48)

Derivatives not designated as hedging instruments:
	Foreign currency forward contracts	Other assets		25		1		-		-
	Foreign currency forward contracts	Accrued expenses		25		(1)		-		-