DERIVATIVE INSTRUMENTS

9 Months Ended

Jul. 31, 2011

DERIVATIVE INSTRUMENTS.

DERIVATIVE INSTRUMENTS

(17) It is the Company’s policy that derivative transactions are executed only to manage exposures arising in the normal course of business and not for the purpose of creating speculative positions or trading. The Company’s financial services operations manage the relationship of the types and amounts of their funding sources to their receivable and lease portfolio in an effort to diminish risk due to interest rate and foreign currency fluctuations, while responding to favorable financing opportunities. The Company also has foreign currency exposures at some of its foreign and domestic operations related to buying, selling and financing in currencies other than the functional currencies.

All derivatives are recorded at fair value on the balance sheet.  Each derivative is designated as a cash flow hedge, a fair value hedge, or remains undesignated.  All designated hedges are formally documented as to the relationship with the hedged item as well as the risk-management strategy.  Both at inception and on an ongoing basis the hedging instrument is assessed as to its effectiveness, when applicable.  If and when a derivative is determined not to be highly effective as a hedge, or the underlying hedged transaction is no longer likely to occur, or the hedge designation is removed, or the derivative is terminated, hedge accounting is discontinued.  Any past or future changes in the derivative’s fair value, which will not be effective as an offset to the income effects of the item being hedged, are recognized currently in the income statement.

Certain of the Company’s derivative agreements contain credit support provisions that require the Company to post collateral based on reductions in credit ratings.  The aggregate fair value of all derivatives with credit-risk-related contingent features that were in a liability position at July 31, 2011, October 31, 2010 and July 31, 2010, was $5 million, $16 million and $34 million, respectively.  The Company, due to its credit rating, has not posted any collateral.  If the credit-risk-related contingent features were triggered, the Company would be required to post full collateral for this liability position, prior to considering applicable netting provisions.

Derivative instruments are subject to significant concentrations of credit risk to the banking sector.  The Company manages individual counterparty exposure by setting limits that consider the credit rating of the counterparty and the size of other financial commitments and exposures between the Company and the counterparty banks.  All interest rate derivatives are transacted under International Swaps and Derivatives Association (ISDA) documentation.  Some of these agreements include collateral support arrangements.  Each master agreement permits the net settlement of amounts owed in the event of early termination.  The maximum amount of loss that the Company would incur if counterparties to derivative instruments fail to meet their obligations, not considering collateral received or netting arrangements, was $406 million, $520 million and $545 million as of July 31, 2011, October 31, 2010 and July 31, 2010, respectively.  The amount of collateral received at July 31, 2011, October 31, 2010 and July 31, 2010 to offset this potential maximum loss was $33 million, $85 million and $78 million, respectively.  The netting provisions of the agreements would reduce the maximum amount of loss the Company would incur if the counterparties to derivative instruments fail to meet their obligations by an additional $13 million, $58 million and $93 million as of July 31, 2011, October 31, 2010 and July 31, 2010, respectively.  None of the concentrations of risk with any individual counterparty was considered significant in any periods presented.

Cash flow hedges

Certain interest rate and cross-currency interest rate contracts (swaps) were designated as hedges of future cash flows from borrowings.  The total notional amounts of the receive-variable/pay-fixed interest rate contracts at July 31, 2011, October 31, 2010 and July 31, 2010 were $350 million, $1,060 million and $1,430 million, respectively, and the notional amount of cross-currency interest rate contracts was $853 million, $849 million and $849 million, respectively.  The effective portions of the fair value gains or losses on these cash flow hedges were recorded in other comprehensive income (OCI) and subsequently reclassified into interest expense or other operating expenses (foreign exchange) in the same periods during which the hedged transactions affected earnings.  These amounts offset the effects of interest rate or foreign currency exchange rate changes on the related borrowings.  Any ineffective portions of the gains or losses on all interest rate contracts designated as hedges were recognized currently in interest expense or other operating expenses (foreign exchange) and were not material during any periods presented.  The cash flows from these contracts were recorded in operating activities in the consolidated statement of cash flows.

The amount of loss recorded in OCI at July 31, 2011 that is expected to be reclassified to interest expense or other operating expenses in the next twelve months if interest rates or exchange rates remain unchanged is approximately $4 million after-tax.  These contracts mature in up to 30 months.  There were no gains or losses reclassified from OCI to earnings based on the probability that the original forecasted transaction would not occur.

Fair value hedges

Certain interest rate contracts (swaps) were designated as fair value hedges of borrowings.  The total notional amounts of these receive-fixed/pay-variable interest rate contracts at July 31, 2011, October 31, 2010 and July 31, 2010 were $7,283 million, $6,640 million and $7,113 million, respectively.  The effective portions of the fair value gains or losses on these contracts were offset by fair value gains or losses on the hedged items (fixed-rate borrowings).  Any ineffective portions of the gains or losses were recognized currently in interest expense.  The ineffective portions were gains of $3 million and $1 million during the third quarter of 2011 and 2010, respectively, and a loss of $2 million and a gain of $1 million during the first nine months of 2011 and 2010, respectively.  The cash flows from these contracts were recorded in operating activities in the consolidated statement of cash flows.

The gains (losses) on these contracts and the underlying borrowings recorded in interest expense were as follows in millions of dollars:

	Three Months Ended				Nine Months Ended
	July 31				July 31
	2011		2010		2011		2010
Interest rate contracts *	$	103	$	134	$	(37)	$	110
Borrowings **	(100)		(133)		35		(109)

*	Includes changes in fair values of interest rate contracts excluding net accrued interest income of $42 million and $54 million during the third quarter of 2011 and 2010 and $129 million and $176 million during the first nine months of 2011 and 2010, respectively.
**	Includes adjustment for fair values of hedged borrowings excluding accrued interest expense of $69 million and $84 million during the third quarter of 2011 and 2010 and $207 million and $261 million during the first nine months of 2011 and 2010, respectively.

Derivatives not designated as hedging instruments

The Company has certain interest rate contracts (swaps and caps), foreign exchange contracts (forwards and swaps) and cross-currency interest rate contracts (swaps), which were not formally designated as hedges.  These derivatives were held as economic hedges for underlying interest rate or foreign currency exposures primarily for certain borrowings and purchases or sales of inventory.  The total notional amounts of these interest rate swaps at July 31, 2011, October 31, 2010 and July 31, 2010 were $2,765 million, $2,702 million and $2,838 million, the foreign exchange contracts were $3,362 million, $2,777 million and $2,343 million and the cross-currency interest rate contracts were $49 million, $60 million and $58 million, respectively.  At July 31, 2011, October 31, 2010 and July 31, 2010, there were also $1,052 million, $1,055 million and $1,135 million, respectively, of interest rate caps purchased and the same amounts sold at the same capped interest rate to facilitate borrowings through securitization of retail notes.  The fair value gains or losses from the interest rate contracts were recognized currently in interest expense and the gains or losses from foreign exchange contracts in cost of sales or other operating expenses, generally offsetting over time the expenses on the exposures being hedged.  The cash flows from these non-designated contracts were recorded in operating activities in the consolidated statement of cash flows.

Fair values of derivative instruments in the condensed consolidated balance sheet in millions of dollars follow:

Other Assets	July 31 2011		October 31 2010		July 31 2010
Designated as hedging instruments:
Interest rate contracts	$	360	$	457	$	496
Not designated as hedging instruments:
Interest rate contracts	28		36		37
Foreign exchange contracts	17		24		8
Cross-currency interest rate contracts	1		3		4
Total not designated	46		63		49
Total derivatives	$	406	$	520	$	545
Accounts Payable and Accrued Expenses
Designated as hedging instruments:
Interest rate contracts	$	1	$	18	$	27
Cross-currency interest rate contracts	7		47		95
Total designated	8		65		122
Not designated as hedging instruments:
Interest rate contracts	11		20		24
Foreign exchange contracts	86		23		32
Cross-currency interest rate contracts	3		1		1
Total not designated	100		44		57
Total derivatives	$	108	$	109	$	179

The classification and gains (losses), which include accrued interest expense, related to derivative instruments on the statement of consolidated income consisted of the following in millions of dollars:

	Expense or	Three Months Ended				Nine Months Ended
	OCI	July 31				July 31
	Classification	2011		2010		2011		2010
Fair Value Hedges:
Interest rate contracts	Interest	$	145	$	188	$	92	$	286
Cash Flow Hedges:
Recognized in OCI
(Effective Portion):
Interest rate contracts	OCI (pretax) *	(2)		(6)		(5)		(12)
Foreign exchange contracts	OCI (pretax) *	(20)		(39)		34		(91)
Reclassified from OCI
(Effective Portion):
Interest rate contracts	Interest *	(3)		(19)		(18)		(58)
Foreign exchange contracts	Other *	(24)		(13)		27		(66)
Recognized Directly in Income
(Ineffective Portion):
Interest rate contracts	Interest	**		**		**		**
Foreign exchange contracts	Other	**		**		**		**
Not Designated as Hedges:
Interest rate contracts	Interest *	$	3	$	5	$	1	$	6
Foreign exchange contracts	Cost of sales	(8)		13		(80)		(14)
Foreign exchange contracts	Other *	1		19		(177)		(21)
Total		$	(4)	$	37	$	(256)	$	(29)

* Includes interest and foreign exchange gains (losses) from cross-currency interest rate contracts.

** The amount is not significant.