Fair Value of Financial Assets and Liabilities

Our fixed income and equity investments are classified as available for sale and recorded at their fair market values. We determine fair value using the following hierarchy:


•	Level 1 – Quoted prices in active markets for identical assets or liabilities.


•	Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.


•	Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

Most of our fixed income securities are classified as Level 2, with the exception of some of our U.S. government and agency obligations and our investments in publicly traded equity securities, which are classified as Level 1, and all of our auction rate securities, which are classified as Level 3. In addition, our strategic investments held at cost are classified as Level 3. At September 30, 2014, the vast majority of our Level 2 securities were priced by pricing vendors. These pricing vendors utilize the most recent observable market information in pricing these securities or, if specific prices are not available for these securities, use other observable inputs like market transactions involving identical or comparable securities. In the event observable inputs are not available, we assess other factors to determine the security’s market value, including broker quotes or model valuations. Each month, we perform independent price verifications of all of our fixed income holdings. In the event a price fails a pre-established tolerance check, it is researched so that we can assess the cause of the variance to determine what we believe is the appropriate fair market value.

In general, investments with remaining effective maturities of 12 months or less from the balance sheet date are classified as short-term investments. Investments with remaining effective maturities of more than 12 months from the balance sheet date are classified as long-term investments. Our publicly traded equity securities are classified as long-term investments and our strategic investments held at cost are classified as other assets. As a result of the lack of liquidity for auction rate securities, we have classified these as long-term investments as of September 30, 2014 and December 31, 2013. At September 30, 2014 and December 31, 2013, all of our short- and long-term investments, excluding auction rate securities, were recognized at fair value, which was determined based upon observable inputs from our pricing vendors for identical or similar assets. At September 30, 2014 and December 31, 2013, auction rate securities were valued using a discounted cash flow model.

The following tables summarize the composition of our short- and long-term investments at September 30, 2014 and December 31, 2013 (tables in millions):



	September 30, 2014
	Amortized Cost		Unrealized Gains		Unrealized (Losses)			Aggregate Fair Value
U.S. government and agency obligations	$	2,321	$	3	$	(2	)	$	2,322
U.S. corporate debt securities	2,285		3		(3		)	2,285
High yield corporate debt securities	559		11		(9		)	561
Asset-backed securities	31		—		—			31
Municipal obligations	984		3		—			987
Auction rate securities	56		—		(4		)	52
Foreign debt securities	2,746		3		(2		)	2,747
Total fixed income securities	8,982		23		(20		)	8,985
Publicly traded equity securities	152		197		(9		)	340
Total	$	9,134	$	220	$	(29	)	$	9,325

We held approximately $2,747 million in foreign debt securities at September 30, 2014. These securities have an average credit rating of A+, and approximately 5% of these securities are deemed sovereign debt with an average credit rating of AA+. None of the securities deemed sovereign debt are from Argentina, Greece, Italy, Ireland, Portugal, Spain or Cyprus.



	December 31, 2013
	Amortized Cost		Unrealized Gains		Unrealized (Losses)			Aggregate Fair Value
U.S. government and agency obligations	$	3,726	$	4	$	(3	)	$	3,727
U.S. corporate debt securities	2,260		8		(2		)	2,266
High yield corporate debt securities	515		19		(3		)	531
Municipal obligations	860		3		—			863
Auction rate securities	63		—		(3		)	60
Foreign debt securities	2,152		6		(3		)	2,155
Total fixed income securities	9,576		40		(14		)	9,602
Publicly traded equity securities	72		24		(1		)	95
Total	$	9,648	$	64	$	(15	)	$	9,697

The following tables represent our fair value hierarchy for our financial assets and liabilities measured at fair value as of September 30, 2014 and December 31, 2013 (tables in millions):



	September 30, 2014
	Level 1		Level 2			Level 3		Total
Cash	$	1,590	$	—		$	—	$	1,590
Cash equivalents	3,965		500			—		4,465
U.S. government and agency obligations	1,316		1,006			—		2,322
U.S. corporate debt securities	—		2,285			—		2,285
High yield corporate debt securities	—		561			—		561
Asset-backed securities	—		31			—		31
Municipal obligations	—		987			—		987
Auction rate securities	—		—			52		52
Foreign debt securities	—		2,747			—		2,747
Publicly traded equity securities	340		—			—		340
Total cash and investments	$	7,211	$	8,117		$	52	$	15,380
Other items:
Strategic investments held at cost	$	—	$	—		$	312	$	312
Investment in joint venture	—		—			36		36
Long-term debt carried at discounted cost	—		(5,475		)	—		(5,475		)
Foreign exchange derivative assets	—		74			—		74
Foreign exchange derivative liabilities	—		(105		)	—		(105		)
Commodity derivative assets	—		2			—		2



	December 31, 2013
	Level 1		Level 2			Level 3		Total
Cash	$	1,725	$	—		$	—	$	1,725
Cash equivalents	5,674		492			—		6,166
U.S. government and agency obligations	1,797		1,930			—		3,727
U.S. corporate debt securities	—		2,266			—		2,266
High yield corporate debt securities	—		531			—		531
Municipal obligations	—		863			—		863
Auction rate securities	—		—			60		60
Foreign debt securities	—		2,155			—		2,155
Publicly traded equity securities	95		—			—		95
Total cash and investments	$	9,291	$	8,237		$	60	$	17,588
Other items:
Strategic investments held at cost	$	—	$	—		$	379	$	379
Investment in joint venture	—		—			35		35
Convertible debt carried at discounted cost	—		(5,419		)	—		(5,419		)
Foreign exchange derivative assets	—		31			—		31
Foreign exchange derivative liabilities	—		(20		)	—		(20		)
Commodity derivative assets	—		4			—		4

Our auction rate securities are predominantly rated investment grade and are primarily collateralized by student loans. The underlying loans of all but one of our auction rate securities, with a market value of $7 million, have partial guarantees by the U.S. government as part of the Federal Family Education Loan Program (“FFELP”) through the U.S. Department of Education. FFELP guarantees at least 95% of the loans which collateralize the auction rate securities. We believe the quality of the collateral underlying most of our auction rate securities will enable us to recover our principal balance.

To determine the estimated fair value of our investment in auction rate securities, we use a discounted cash flow model using a five year time horizon. As of September 30, 2014, the coupon rates used ranged from 0% to 3% and the discount rate was 1%, which rate represents the rate at which similar FFELP backed securities with a five year time horizon outside of the auction rate securities market were trading at September 30, 2014. The assumptions used in preparing the discounted cash flow model include an incremental discount rate for the lack of liquidity in the market (“liquidity discount margin”) for an estimated period of time. The discount rate we selected was based on AA-rated banks as the majority of our portfolio is invested in student loans where EMC acts as a financier to these lenders. The liquidity discount margin represents an estimate of the additional return an investor would require for the lack of liquidity of these securities over an estimated five year holding period. The rate used for the discount margin was 1% at both September 30, 2014 and December 31, 2013 due to the narrowing of credit spreads on AA-rated banks during 2013 and into 2014.

The following table provides a summary of changes in fair value of our Level 3 auction rate securities for the three and nine months ended September 30, 2014 and 2013 (table in millions):



	For the Three Months Ended						For the Nine Months Ended
	September 30, 2014			September 30, 2013			September 30, 2014			September 30, 2013
Balance, beginning of the period	$	59		$	68		$	60		$	70
Calls at par value	(7		)	—			(7		)	(1		)
Other-than-temporary impairment loss	—			—			—			(1		)
(Increase) decrease in previously recognized unrealized losses included in other comprehensive income	—			(1		)	(1		)	(1		)
Balance, end of the period	$	52		$	67		$	52		$	67

Significant changes in the unobservable inputs discussed above could result in a significantly lower or higher fair value measurement. Generally, an increase in the discount rate, liquidity discount margin or coupon rate results in a decrease in our fair value measurement and a decrease in the discount rate, liquidity discount margin or coupon rate results in an increase in our fair value measurement.

EMC has a 49% ownership percentage of LenovoEMC Limited, a joint venture with Lenovo that was formed in 2012. We account for our LenovoEMC joint venture using the fair value method of accounting. To determine the estimated fair value at inception of our investment, we used a discounted cash flow model using a three year time horizon, and utilized a discount rate of 6%, which represented the incremental borrowing rate for a market participant. The assumptions used in preparing the discounted cash flow model include an analysis of estimated Lenovo NAS revenue against a prescribed target as well as consideration of the purchase price put and call features included in the joint venture agreement. The put and call features create a floor and a cap on the fair value of the investment. As such, there is a limit to the impact on the fair value that would result from significant changes in the unobservable inputs. We had no changes to the assumptions utilized in the fair value calculation in the third quarter of 2014.

The following table provides a summary of changes in fair value of our LenovoEMC joint venture for the three and nine months ended September 30, 2014 and 2013 (table in millions):



	For the Three Months Ended				For the Nine Months Ended
	September 30, 2014		September 30, 2013		September 30, 2014		September 30, 2013
Balance, beginning of the period	$	36	$	34	$	35	$	33
Realized gain included in other expense, net	—		—		1		1
Balance, end of period	$	36	$	34	$	36	$	34

The carrying value of the strategic investments held at cost were accounted for under the cost method. As part of our quarterly impairment review, we perform a fair value calculation of our strategic investments held at cost using the most currently available information. To determine the estimated fair value of private strategic investments held at cost, we use a combination of several valuation techniques including discounted cash flow models, acquisition and trading comparables. In addition, we evaluate the impact of pre- and post-money valuations of recent financing events and the impact of those on our fully diluted ownership percentages, and we consider any available information regarding the issuer’s historical and forecasted performance as well as market comparables and conditions. The fair value of these investments is considered in our review for impairment if any events and changes in circumstances occur that might have a significant adverse effect on their value.

Investment Losses

Unrealized losses on investments at September 30, 2014 by investment category and length of time the investment has been in a continuous unrealized loss position are as follows (table in millions):



	Less Than 12 Months					12 Months or Greater					Total
	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
U.S. government and agency obligations	$	938	$	(2	)	$	—	$	—		$	938	$	(2	)
U.S. corporate debt securities	986		(3		)	—		—			986		(3		)
High yield corporate debt securities	264		(9		)	—		—			264		(9		)
Auction rate securities	—		—			52		(4		)	52		(4		)
Foreign debt securities	1,159		(2		)	—		—			1,159		(2		)
Publicly traded equity securities	21		(8		)	—		(1		)	21		(9		)
Total	$	3,368	$	(24	)	$	52	$	(5	)	$	3,420	$	(29	)

For all of our securities for which the amortized cost basis was greater than the fair value at September 30, 2014, we have concluded that currently we neither plan to sell the security nor is it more likely than not that we would be required to sell the security before its anticipated recovery. In making the determination as to whether the unrealized loss is other-than-temporary, we considered the length of time and extent the investment has been in an unrealized loss position, the financial condition and near-term prospects of the issuers, the issuers’ credit rating and the time to maturity.

In the second quarter of 2014, an unrealized gain of $88 million was recorded in other comprehensive income related to a strategic investment which completed an initial public offering in June 2014. This investment was reclassified from our portfolio of strategic investments held at cost to publicly traded equity securities. An additional unrealized gain of $76 million related to this strategic investment was recorded in other comprehensive income during the third quarter of 2014.

Contractual Maturities

The contractual maturities of fixed income securities held at September 30, 2014 are as follows (table in millions):



	September 30, 2014
	Amortized Cost Basis		Aggregate Fair Value
Due within one year	$	2,039	$	2,041
Due after 1 year through 5 years	5,974		5,978
Due after 5 years through 10 years	550		550
Due after 10 years	419		416
Total	$	8,982	$	8,985

Short-term investments on the consolidated balance sheet include $51 million in variable rate notes which have contractual maturities in 2014, and are not classified within investments due within one year above.