Financial Instruments

The fair value of the Company’s financial instruments is generally determined by reference to market values resulting from trading on a national securities exchange or in an over-the-counter market. In some cases where quoted market prices are not available, prices are derived by considering the yield of the benchmark security that was issued to initially price the instruments and adjusting this rate by the credit spread that market participants would demand for the instruments as of the measurement date. The carrying amounts of cash and cash equivalents, accounts receivable, program cash and accounts payable and accrued liabilities approximate fair value due to the short-term maturities of these assets and liabilities.

Debt Instruments

The carrying amounts and estimated fair values of debt instruments were as follows:



	As of March 31, 2013				As of December 31, 2012
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Corporate debt
Short-term debt and current portion of long-term debt ^(a)	$	29	$	29	$	57	$	58
Long-term debt, excluding convertible debt ^(a)	3,241		3,443		2,720		2,903
Convertible debt ^(a)	77		133		128		171

Debt under vehicle programs
Vehicle-backed debt due to Avis Budget Rental Car Funding (AESOP) LLC ^(a)	$	5,873	$	6,074	$	5,203	$	5,391
Vehicle-backed debt ^(a)	1,586		1,602		1,599		1,613
Interest rate swaps and interest rate contracts ^(b)	3		3		4		4

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^(a)	The fair value measurements are based on significant observable inputs (Level 2).


^(b)	Derivatives in a liability position.

Net Investment Hedge

The Company has designated its 6% Euro-denominated notes issued March 2013 as a hedge of its net investment in Euro-denominated foreign operations. The Company records the effective portion of the gain or loss on this net investment hedge, net of taxes, in accumulated other comprehensive income as part of the currency translation adjustments. For the three months ended March 31, 2013, the Company has recorded a $3 million gain, net of tax, in accumulated other comprehensive income. Any ineffective portion of the net investment hedge is immediately reclassified from accumulated other comprehensive income into earnings. There was no ineffectiveness during the three months ended March 31, 2013 and the Company does not expect to reclassify any amounts related to this net investment hedge from accumulated other comprehensive income to earnings over the next 12 months.

Derivative Instruments and Hedging Activities

The Company uses foreign exchange contracts to manage its exposure to changes in currency exchange rates associated with its foreign currency denominated receivables and forecasted royalties, forecasted earnings of foreign subsidiaries and forecasted foreign currency denominated acquisitions. The Company primarily hedges its foreign currency exposure to the Australian, Canadian and New Zealand dollars, the Euro and the British pound sterling. The majority of forward contracts do not qualify for hedge accounting treatment. The fluctuations in the value of these forward contracts do, however, largely offset the impact of changes in the value of the underlying risk they economically hedge. The amount of gains or losses reclassified from accumulated other comprehensive income to earnings resulting from ineffectiveness or from excluding a component of the forward contracts’ gain or loss from the effectiveness calculation for cash flow hedges during the three months ended March 31, 2013 and 2012 was not material, nor is the amount of gains or losses the Company expects to reclassify from accumulated other comprehensive income to earnings over the next 12 months.

The Company uses various hedging strategies including interest rate swaps and interest rate caps to create an appropriate mix of fixed and floating rate assets and liabilities. The Company uses interest rate swaps to manage the risk related to its floating rate corporate debt and its floating rate vehicle-backed debt. The Company records the effective portion of changes in the fair value of its cash flow hedges to other comprehensive income, net of tax, and subsequently reclassifies these amounts into earnings in the period during which the hedged transaction is recognized. The Company records the gains or losses related to freestanding derivatives, which are not designated as a hedge for accounting purposes, in its consolidated results of operations. The changes in fair values of hedges that were determined to be ineffective are immediately reclassified from accumulated other comprehensive income into earnings. The Company estimates that approximately $1 million of losses currently recorded in accumulated other comprehensive income will be recognized in earnings over the next 12 months, which is expected to be offset in earnings by the impact of the underlying hedged items.

From time to time, the Company enters into derivative commodity contracts to manage its exposure to changes in the price of unleaded gasoline. Changes in the fair value of these derivatives are recorded within operating expenses.

Certain of the Company’s derivative instruments contain collateral support provisions that require the Company to post cash collateral to the extent that such derivatives are in a liability position. The aggregate fair value of such derivatives and the aggregate fair value of assets needed to settle these derivatives as of March 31, 2013 was approximately $4 million, for which the Company has posted cash collateral in the normal course of business.

As of March 31, 2013, the Company held derivative instruments with absolute notional values as follows:



	As of
	March 31, 2013
Interest rate caps ^(a)	$	6,992
Interest rate swaps	913
Foreign exchange forward contracts	252
Foreign exchange swaps	763

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^(a)	Represents $4.7 billion of interest rate caps sold, partially offset by approximately $2.3 billion of interest rate caps purchased, which amount excludes $2.4 billion of interest rate caps purchased by the Company’s Avis Budget Rental Car Funding (AESOP) LLC (“Avis Budget Rental Car Funding”) subsidiary.

As of March 31, 2013, the Company also had commodity contracts for the purchase of 9 million gallons of unleaded gasoline.

The Company used significant observable inputs (Level 2 inputs) to determine the fair value of its derivative assets and liabilities. Derivatives entered into by the Company are typically executed over-the-counter and are valued using various valuation techniques, as no quoted market prices exist for such instruments. The valuation technique and inputs depend on the type of derivative and the nature of the underlying exposure. The principal techniques used to value these instruments are discounted cash flows and Black-Scholes option valuation models. These models take into account a variety of factors including, where applicable, maturity, commodity prices, interest rate yield curves of the Company and counterparties, credit curves, counterparty creditworthiness and currency exchange rates. These factors are applied on a consistent basis and are based upon observable inputs where available.

Fair values of derivative instruments were as follows:



	As of March 31, 2013				As of December 31, 2012
	Fair Value, Asset Derivatives		Fair Value, Liability Derivatives		Fair Value, Asset Derivatives		Fair Value, Liability Derivatives
Derivatives designated as hedging instruments
Interest rate swaps ^(a)	$	—	$	—	$	—	$	1

Derivatives not designated as hedging instruments
Currency exchange contracts ^(b)	8		8		3		8
Interest rate contracts ^(c)	—		3		—		4
Interest rate swaps ^(a)	—		9		—		12
Commodity contracts ^(b)	2		—		—		—
Total	$	10	$	20	$	3	$	25

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Amounts in this table exclude derivatives issued by Avis Budget Rental Car Funding, as it is not consolidated by the Company; however, certain amounts related to the derivatives held by Avis Budget Rental Car Funding are included within accumulated other comprehensive income, as discussed in Note 14—Stockholders’ Equity.


^(a)	Included in other non-current liabilities.


^(b)	Included in other current assets and other current liabilities.


^(c)	Included in assets under vehicle programs and liabilities under vehicle programs.

The effect of derivatives recognized in the Company’s Consolidated Condensed Financial Statements were as follows:



	Three Months Ended March 31,
	2013		2012
Derivatives designated as hedging instruments
Interest rate swaps ^(a)	$	—	$	7

Derivatives not designated as hedging instruments
Currency exchange contracts ^(b)	1		(4		)
Commodity contracts ^(c)	2		6
Interest rate contracts ^(d)	3		(5		)
Total	$	6	$	4

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^(a)	Recognized, net of tax, as a component of other comprehensive income within stockholders’ equity.


^(b)	For the three months ended March 31, 2013, included a $2 million gain in operating expenses, and included a $1 million loss in interest expense. For the three months ended March 31, 2012, amounts were included in operating expenses.


^(c)	Included in operating expense.


^(d)	Included in interest expense.