FINANCIAL INSTRUMENTS

Tredegar uses derivative financial instruments for the purpose of hedging margin exposure from fixed-price forward sales contracts in Aluminum Extrusions and exposure from currency volatility that exist as part of ongoing business operations (primarily in Flexible Packaging Films). These derivative financial instruments are designated as and qualify as cash flow hedges and are recognized in the consolidated balance sheet at fair value. The fair value of derivative instruments recorded on the consolidated balance sheets are based upon Level 2 inputs. If individual derivative instruments with the same counterparty can be settled on a net basis, the Company records the corresponding derivative fair values as a net asset or net liability.

In the normal course of business, Aluminum Extrusions enters into fixed-price forward sales contracts with certain customers for the future sale of fixed quantities of aluminum extrusions at scheduled intervals. In order to hedge margin exposure created from the fixing of future sales prices relative to volatile raw material (aluminum) costs, Aluminum Extrusions enters into a combination of forward purchase commitments and futures contracts to acquire or hedge aluminum, based on the scheduled purchases for the firm sales commitments. The fixed-price firm sales commitments and related hedging instruments generally have durations of not more than 12 months, and the notional amount of aluminum futures contracts that hedged future purchases of aluminum to meet fixed-price forward sales contract obligations was $25.4 million (22.5 million pounds of aluminum) at December 31, 2018 and $8.2 million (8.0 million pounds of aluminum) at December 31, 2017.

The table below summarizes the location and gross amounts of aluminum derivative contract fair values (Level 2) in the consolidated balance sheets as of December 31, 2018 and 2017:



	December 31, 2018				December 31, 2017
(In thousands)	Balance Sheet Account	Fair Value			Balance Sheet Account	Fair Value
Derivatives Designated as Hedging Instruments
Asset derivatives: Aluminum futures contracts	Prepaid expenses and other	$	20		Prepaid expenses and other	$	578
Liability derivatives:
Aluminum futures contracts	Prepaid expenses and other	(1,650		)	Prepaid expenses and other	(16		)

Derivatives Not Designated as Hedging Instruments
Asset derivatives: Aluminum futures contracts	Prepaid expenses and other	$	—		Prepaid expenses and other	$	—
Liability derivatives: Aluminum futures contracts	Prepaid expenses and other	—			Prepaid expenses and other	—
Net asset (liability)		$	(1,630	)		$	562

In the event that a counterparty to an aluminum fixed-price forward sales contract chooses not to take delivery of its aluminum extrusions, the customer is contractually obligated to compensate Aluminum Extrusions for any losses on the related aluminum futures and/or forward contracts through the date of cancellation.

The table below summarizes the location and gross amounts of foreign currency forward contract fair values (Level 2) in the consolidated balance sheets as of December 31, 2018 and 2017:



	December 31, 2018				December 31, 2017
(In thousands)	Balance Sheet Account	Fair Value			Balance Sheet Account	Fair Value
Derivatives Designated as Hedging Instruments
Asset derivatives: Foreign currency forward contracts	Prepaid expenses and other	$	37		Accrued Expenses	$	—
Liability derivatives: Foreign currency forward contracts	Accrued Expenses	(1,090		)	Accrued Expenses	(558		)

Derivatives Not Designated as Hedging Instruments
Asset derivatives: Foreign currency forward contracts	Accrued Expenses	$	—		Accrued Expenses	$	—
Liability derivatives: Foreign currency forward contracts	Accrued Expenses	—			Accrued Expenses	—
Net asset (liability)		$	(1,053	)		$	(558	)

The Company's earnings are exposed to foreign currency exchange risk primarily through the translation of the financial statements of subsidiaries that have a functional currency other than the U.S. Dollar. The Company estimates that the net mismatch translation exposure between Flexible Packaging Films business unit in Brazil, Terphane Limitada's (“Terphane Ltda.”) U.S. Dollar quoted or priced sales and underlying Brazilian Real (“R$”) quoted or priced operating costs (excluding depreciation and amortization) is annual net costs of R$125 million. Terphane Ltda. has the following outstanding foreign exchange average forward rate contracts to purchase Brazilian Real and sell U.S. Dollars:



USD Notional Amount (000s)	Average Forward Rate Contracted on USD/BRL	R$ Equivalent Amount (000s)	Applicable Month	Estimated % of Terphane Ltda. R$ Operating Cost Exposure Hedged
$2,025	3.6442	R$7,380	Jan-19	73%
$2,025	3.6527	R$7,397	Feb-19	75%
$2,025	3.6593	R$7,410	Mar-19	70%
$2,025	3.6690	R$7,430	Apr-19	72%
$2,025	3.6795	R$7,451	May-19	73%
$2,025	3.6904	R$7,473	Jun-19	72%
$1,800	3.8826	R$6,989	Jul-19	65%
$1,800	3.8950	R$7,011	Aug-19	68%
$1,800	3.9070	R$7,033	Sep-19	66%
$1,800	3.9203	R$7,056	Oct-19	67%
$1,800	3.9331	R$7,080	Nov-19	67%
$1,800	3.9455	R$7,102	Dec-19	73%
$22,950	3.7826	R$86,812		70%

These foreign currency exchange contracts have been designated and qualify as cash flow hedges of Terphane Limitada's forecasted sales to customers quoted or priced in U.S. Dollars over that period. By changing the currency risk associated with these U.S. Dollar sales, the derivatives have the effect of offsetting operating costs quoted or priced in Brazilian Real and decreasing the net exposure to Brazilian Real in the consolidated statements of income. The net fair value of the open forward contracts was a negative $0.9 million as of December 31, 2018.

These derivative contracts involve elements of market risk that are not reflected on the consolidated balance sheet, including the risk of dealing with counterparties and their ability to meet the terms of the contracts. The counterparties to any forward purchase commitments are major aluminum brokers and suppliers, and the counterparties to any aluminum futures contracts are major financial institutions. Fixed-price forward sales contracts are only made available to the best and most credit-worthy customers. The counterparties to the Company’s foreign currency cash flow hedge contracts are major financial institutions.

The pretax effect on net income (loss) and other comprehensive income (loss) of derivative instruments classified as cash flow hedges and described in the previous paragraphs for years ended December 31, 2018, 2017, and 2016 is summarized in the tables below:



(In thousands)	Cash Flow Derivative Hedges
	Aluminum Futures Contracts
Years Ended December 31,	2018			2017		2016
Amount of pre-tax gain (loss) recognized in other comprehensive income	$	(1,123	)	$	1,501	$	394
Location of gain (loss) reclassified from accumulated other comprehensive income into net income (effective portion)	Cost of goods sold			Cost of goods sold		Cost of goods sold
Amount of pre-tax gain (loss) reclassified from accumulated other comprehensive income to net income (effective portion)	$	1,069		$	1,210	$	(1,630	)



(In thousands)	Cash Flow Derivative Hedges
	Foreign Currency Forward Contracts
Years Ended December 31,	2018					2017					2016
Amount of pre-tax gain (loss) recognized in other comprehensive income	$	—	$	(2,105	)	$	—	$	(561	)	$	—
Location of gain (loss) reclassified from accumulated other comprehensive income into net income (effective portion)	Cost of goods sold		Selling, general & admin			Cost of goods sold		Selling, general & admin			Cost of goods sold
Amount of pre-tax gain (loss) reclassified from accumulated other comprehensive income to net income (effective portion)	$	62	$	(1,796	)	$	62	$	(43	)	$	62

Gains and losses on the ineffective portion of derivative instruments or derivative instruments that were not designated as hedging instruments were not material in 2018, 2017 and 2016. For the years ended December 31, 2018, 2017 and 2016, unrealized net losses from hedges that were discontinued were not material. As of December 31, 2018, the Company expected $1.1 million of unrealized after-tax losses on derivative instruments reported in accumulated other comprehensive income to be reclassified to earnings within the next 12 months.