DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES

In the normal course of business, our operations are exposed to global market risks, including the effect of changes in foreign currency exchange rates, certain commodity prices, and interest rates. To manage these risks, we enter into various derivatives contracts:


•	Foreign currency exchange contracts, including forwards and options, that are used to manage foreign exchange exposure;


•	Commodity contracts, including forwards and options, that are used to manage commodity price risk;


•	Interest rate contracts including swaps, caps, and floors that are used to manage the effects of interest rate fluctuations; and


•	Cross-currency interest rate swap contracts that are used to manage foreign currency and interest rate exposures on foreign-denominated debt.

Our derivatives are over-the-counter customized derivative transactions and are not exchange-traded. We review our hedging program, derivative positions, and overall risk management strategy on a regular basis.

Derivative Financial Instruments and Hedge Accounting. All derivatives are recognized on the balance sheet at fair value. We do not net our derivative position by counterparty for purposes of balance sheet presentation and disclosure. We do, however, consider our net position for determining fair value.

We have elected to apply hedge accounting to certain derivatives. Derivatives that are designated in hedging relationships are evaluated for effectiveness using regression analysis at the time they are designated and throughout the hedge period. Cash flows and the profit impact associated with designated hedges are reported in the same category as the underlying hedged item.

Some derivatives do not qualify for hedge accounting; for others, we elect not to apply hedge accounting. Regardless, we only enter into transactions that we believe will be highly effective at offsetting the underlying economic risk. We report changes in the fair value of derivatives not designated as hedging instruments through Automotive cost of sales, Automotive interest income and other non-operating income/(expense), net, or Financial Services other income/(loss), net depending on the sector and underlying exposure. Cash flows associated with non-designated or de-designated derivatives are reported in Net cash (used in)/provided by investing activities in our statements of cash flows.

Cash Flow Hedges. Our Automotive sector has designated certain forward contracts as cash flow hedges of forecasted transactions with exposure to foreign currency exchange risk.

The effective portion of changes in the fair value of cash flow hedges is deferred in Accumulated other comprehensive income/(loss) and is recognized in Automotive cost of sales when the hedged item affects earnings. The ineffective portion is reported in Automotive cost of sales. Our policy is to de-designate cash flow hedges prior to the time forecasted transactions are recognized as assets or liabilities on the balance sheet and report subsequent changes in fair value through Automotive cost of sales. If it becomes probable that the originally-forecasted transaction will not occur, the related amount also is reclassified from Accumulated other comprehensive income/(loss) and recognized in earnings. Our cash flow hedges mature in two years or less.

Fair Value Hedges. Our Financial Services sector uses derivatives to reduce the risk of changes in the fair value of liabilities. We have designated certain receive-fixed, pay-float interest rate swaps as fair value hedges of fixed-rate debt. The risk being hedged is the risk of changes in the fair value of the hedged debt attributable to changes in the benchmark interest rate. If the hedge relationship is deemed to be highly effective, we record the changes in the fair value of the hedged debt related to the risk being hedged in Financial Services debt with the offset in Financial Services other income/(loss), net. The change in fair value of the related derivative (excluding accrued interest) also is recorded in Financial Services other income/(loss), net. Hedge ineffectiveness, recorded directly in earnings, is the difference between the change in fair value of the derivative and the change in the value of the hedged debt that is attributable to the changes in the benchmark interest rate.

NOTE 25. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES (Continued)

For our Financial Services sector, net interest settlements and accruals on fair value hedges are excluded from the assessment of hedge effectiveness. We report net interest settlements and accruals on fair value hedges in Interest expense, with the exception of foreign currency revaluation on accrued interest, which is reported in Selling, administrative, and other expenses. Ineffectiveness on fair value hedges and gains and losses on interest rate contracts not designated as hedging instruments are reported in Financial Services other income/(loss), net. Gains and losses on foreign exchange and cross-currency interest rate swap contracts not designated as hedging instruments are reported in Selling, administrative, and other expenses.

When a fair value hedge is de-designated, or when the derivative is terminated before maturity, the fair value adjustment to the hedged debt continues to be reported as part of the carrying value of the debt and is amortized over its remaining life.

Net Investment Hedges. We have used foreign currency exchange derivatives to hedge the net assets of certain foreign entities to offset the translation and economic exposures related to our investment in these entities. The effective portion of changes in the value of designated instruments is included in Accumulated other comprehensive income/(loss) as a foreign currency translation adjustment until the hedged investment is sold or liquidated. When the investment is sold or liquidated, the hedge gains and losses previously reported in Accumulated other comprehensive income/(loss) are recognized in Automotive interest income and other non-operating income/(expense), net as part of the gain or loss on sale. Presently, we have had no derivative instruments in an active net investment hedging relationship. We have elected the spot to spot method.

Normal Purchases and Normal Sales Classification. We have elected to apply the normal purchases and normal sales classification for physical supply contracts that are entered into for the purpose of procuring commodities to be used in production over a reasonable period in the normal course of our business.

NOTE 25. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES (Continued)

Income Effect of Derivative Instruments

The following tables summarize by hedge designation the pre-tax gains/(losses) recorded in Other comprehensive income/(loss) ("OCI"), reclassified from Accumulated other comprehensive income/(loss) ("AOCI") to income and/or recognized directly in income (in millions):



	2011									2010								2009
	Gain/(Loss) Recorded in OCI			Gain/(Loss) Reclassified from AOCI to Income			Gain/(Loss) Recognized in Income			Gain/(Loss) Recorded in OCI			Gain/(Loss) Reclassified from AOCI to Income		Gain/(Loss) Recognized in Income			Gain/(Loss) Recorded in OCI			Gain/(Loss) Reclassified from AOCI to Income			Gain/(Loss) Recognized in Income
Automotive Sector
Cash flow hedges:
Foreign currency exchange contracts	$	(100	)	$	119	(a)	$	(3	)	$	(7	)	$	17	$	—		$	(86	)	$	37	(b)	$	(1	)
Commodity contracts	—			—			—			—			—		—			—			4			—
Total	$	(100	)	$	119		$	(3	)	$	(7	)	$	17	$	—		$	(86	)	$	41		$	(1	)
Derivatives not designated as hedging instruments:
Foreign currency exchange contracts - operating exposures							$	20							$	(183	)							$	(120	)
Foreign currency exchange contracts - investment portfolios							—								—									(11		)
Commodity contracts							(423		)						68									(4		)
Other – warrants							(1		)						2									(12		)
Total							$	(404	)						$	(113	)							$	(147	)

Financial Services Sector
Fair value hedges:
Interest rate contracts
Net interest settlements and accruals excluded from the assessment of hedge effectiveness							$	217							$	225								$	164
Ineffectiveness (c)							(30		)						(6		)							(13		)
Total							$	187							$	219								$	151
Derivatives not designated as hedging instruments:
Interest rate contracts							$	(5	)						$	38								$	(63	)
Foreign currency exchange contracts							(48		)						(88		)							(268		)
Cross-currency interest rate swap contracts							(3		)						(1		)							12
Other (d)							65								—									—
Total							$	9							$	(51	)							$	(319	)

__________


(a)	Includes $3 million loss reclassified from AOCI to income in fourth quarter 2011 attributable to transactions no longer probable to occur, related to Ford of Thailand.


(b)	Includes $4 million gain reclassified from AOCI to income in first quarter 2009 attributable to transactions no longer probable to occur, primarily related to Volvo.


(c)	For 2011, 2010 and 2009, hedge ineffectiveness reflects change in fair value on derivatives of $433 million gain, $117 million gain, and $46 million loss, respectively, and change in fair value on hedged debt of $463 million loss, $123 million loss, and $33 million gain, respectively.


(d)	Reflects gains/(losses) for derivative features included in the FUEL notes (see Note 4).

In 2010, a net gain of $7 million of foreign currency translation on net investment hedges was transferred from Accumulated other comprehensive income/(loss) to earnings due to the sale of investments in foreign affiliates.

NOTE 25. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES (Continued)

Accumulated Other Comprehensive Income/(Loss) Activity

The following table summarizes activity on a pre-tax basis in Accumulated other comprehensive income/(loss) related to designated cash flow hedges for the years ended December 31 (in millions):



	2011			2010			2009
Beginning of year: net unrealized gain/(loss) on derivative financial instruments	$	(22	)	$	2		$	129
Increase/(Decrease) in fair value of derivatives	(100		)	(7		)	(86		)
Gains reclassified from Accumulated other comprehensive income/(loss)	(119		)	(17		)	(41		)
End of year: net unrealized gain/(loss) on derivative financial instruments	$	(241	)	$	(22	)	$	2

We expect to reclassify existing net losses of $158 million from Accumulated other comprehensive income/(loss) to Automotive cost of sales during the next twelve months as the underlying exposures are realized.

Balance Sheet Effect of Derivative Instruments

The following tables summarize the notional amount and estimated fair value of our derivative financial instruments at December 31 (in millions):



	2011
	Notionals		Fair Value of Assets		Fair Value of Liabilities
Automotive Sector
Cash flow hedges:
Foreign currency exchange contracts	$	14,535	$	120	$	368

Derivatives not designated as hedging instruments:
Foreign currency exchange contracts	5,692		92		80
Commodity contracts	2,396		2		372
Other – warrants	12		4		—
Total derivatives not designated as hedging instruments	8,100		98		452
Total Automotive sector derivative instruments	$	22,635	$	218	$	820

Financial Services Sector
Fair value hedges:
Interest rate contracts	$	7,786	$	526	$	—

Derivatives not designated as hedging instruments:
Interest rate contracts	70,639		670		237
Foreign currency exchange contracts	3,582		30		50
Cross-currency interest rate swap contracts	987		12		12
Other (a)	2,500		137		—
Total derivatives not designated as hedging instruments	77,708		849		299
Total Financial Services sector derivative instruments	$	85,494	$	1,375	$	299

__________


(a)	Represents derivative features included in the FUEL notes (see Note 4).

NOTE 25. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES (Continued)



	2010
	Notionals		Fair Value of Assets		Fair Value of Liabilities
Automotive Sector
Cash flow hedges:
Foreign currency exchange contracts	$	1,324	$	8	$	15

Derivatives not designated as hedging instruments:
Foreign currency exchange contracts	6,100		50		78
Commodity contracts	846		69		6
Other – warrants	12		5		—
Total derivatives not designated as hedging instruments	6,958		124		84
Total Automotive sector derivative instruments	$	8,282	$	132	$	99

Financial Services Sector
Fair value hedges:
Interest rate contracts	$	8,826	$	503	$	7

Derivatives not designated as hedging instruments:
Interest rate contracts	52,999		709		322
Foreign currency exchange contracts	3,835		24		73
Cross-currency interest rate swap contracts	1,472		25		189
Total derivatives not designated as hedging instruments	58,306		758		584
Total Financial Services sector derivative instruments	$	67,132	$	1,261	$	591

On our consolidated balance sheet, derivative assets are reported in Other assets for Automotive and Financial Services sectors, and derivative liabilities are reported in Payables for our Automotive sector and in Accrued liabilities and deferred revenue for our Financial Services sector.

The notional amounts of the derivative financial instruments do not represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the financial risks described above. Notional amounts are presented on a gross basis with no netting of offsetting exposure positions. The amounts exchanged are calculated by reference to the notional amounts and by other terms of the derivatives, such as interest rates, foreign currency exchange rates or commodity volumes and prices.

Counterparty Risk and Collateral

Use of derivatives exposes us to the risk that a counterparty may default on a derivative contract. We establish exposure limits for each counterparty to minimize this risk and provide counterparty diversification. Substantially all of our derivative exposures are with counterparties that have an investment grade rating. The aggregate fair value of derivative instruments in asset positions on December 31, 2011 was $1.6 billion, representing the maximum loss that we would recognize at that date if all counterparties failed to perform as contracted. We enter into master agreements with counterparties that generally allow for netting of certain exposures; therefore, the actual loss we would recognize if all counterparties failed to perform as contracted would be significantly lower.

We include an adjustment for non-performance risk in the fair value of derivative instruments. Our adjustment for non-performance risk is relative to a measure based on an unadjusted inter-bank deposit rate (e.g., LIBOR). For our Automotive sector, at December 31, 2011 and 2010, our adjustment reduced derivative assets by $3 million and less than $1 million, respectively, and reduced derivative liabilities by $10 million and less than $1 million, respectively. For our Financial Services sector, at December 31, 2011 and 2010, our adjustment reduced derivative assets by $54 million and $10 million, respectively, and reduced derivative liabilities by $7 million and $4 million, respectively. See Note 4 for more detail on valuation methodologies.

We post cash collateral with certain counterparties based on our net position with regard to foreign currency and commodity derivative contracts. We posted $70 million and $11 million as of December 31, 2011 and December 31, 2010, respectively, which is reported in Other assets on our consolidated balance sheet.