Ford 2005 Annual Report Download - page 52

Quantitative and Qualitative Disclosures About Market Risk
The net fair value of financial instruments with exposure to cash flow foreign currency risk was a liability of $400 million as of
December 31, 2005 compared to a net fair value asset of $1.4 billion as of December 31, 2004. The potential decrease in fair value for
such financial instruments, assuming a 10% adverse change in quoted foreign currency exchange rates, would be $1.3 billion and
$1.5 billion at December 31, 2005 and December 31, 2004, respectively.
Commodity Price Risk. Commodity price risk is the possibility of higher or lower costs due to changes in the prices of
commodities, such as non-ferrous metals (e.g., aluminum), precious metals (e.g., palladium), ferrous metals (e.g., steel and iron
castings), energy (e.g., natural gas and electricity), and plastics/resins (e.g., polypropylene), which we use in the production of motor
vehicles. Steel and resins are our two largest commodity exposures and are among the most difficult to hedge.
We use derivative instruments to hedge the price risk associated with the purchase of those commodities that we can economically
hedge (primarily non-ferrous metals, precious metals and energies). In our hedging actions, we primarily use instruments commonly
used by corporations to reduce commodity price risk (e.g., financially settled forward contracts, swaps, and options).
The net fair value asset of commodity forward and option contracts as of December 31, 2005 and December 31, 2004 was
$664 million and $294 million, respectively. The potential decrease in fair value of commodity forward and option contracts,
assuming a 10% adverse change in the underlying commodity price, would be approximately $200 million at both December 31, 2005
and December 31, 2004.
In addition, our purchasing organization (with guidance from the GRMC as appropriate) negotiates contracts to ensure continuous
supply of raw materials. In some cases, these contracts stipulate minimum purchase amounts and specific prices, and as such, play a
role in managing price risk.
Interest Rate Risk. Interest rate risk relates to the gain or loss we could incur in our Automotive investment portfolio due to a
change in interest rates. Our interest rate sensitivity analysis on the investment portfolio includes cash and cash equivalents,
marketable and loaned securities and short-term VEBA assets. At December 31, 2005, we had $25.1 billion in our Automotive
investment portfolio, compared to $23.6 billion at December 31, 2004. We invest the portfolio in securities of various types and
maturities, the value of which are subject to fluctuations in interest rates. These securities are generally classified as either trading or
available-for-sale. The trading portfolio gains and losses (unrealized and realized) are reported in the income statement. The
available-for-sale portfolio realized gains or losses are reported in the income statement, and unrealized gains and losses are reported
in the Consolidated Statement of Stockholdersʼ Equity in other comprehensive income. The investment strategy is based on clearly
defined risk and liquidity guidelines to maintain liquidity, minimize risk, and earn a reasonable return on the short-term investment.
At any time, a rise in interest rates could have a material adverse impact on the fair value of our trading and available-for-sale
portfolios. As of December 31, 2005, the value of our trading portfolio was $22.6 billion, which is $3.0 billion higher than
December 31, 2004. The value of our available-for-sale portfolio was $2.5 billion, which is $1.5 billion lower than
December 31, 2004.
Assuming a hypothetical increase in interest rates of one percentage point, the value of our trading and available-for-sale portfolios
would be reduced by $91 million and $28 million, respectively. This compares to $88 million and $45 million, respectively, as
calculated as of December 31, 2004. While these are our best estimates of the impact of the specified interest rate scenario, actual
results could differ from those projected. The sensitivity analysis presented assumes interest rate changes are instantaneous, parallel
shifts in the yield curve. In reality, interest rate changes of this magnitude are rarely instantaneous or parallel.
Counterparty Risk. The use of derivatives to manage market risk results in counterparty risk, which is the loss we could incur if a
counterparty defaulted on a derivative contract. We enter into master agreements with counterparties that allow netting of certain
exposures in order to manage this risk. Exposures primarily relate to derivative contracts used for managing interest rate, foreign
currency exchange rate and commodity price risk. We, together with Ford Credit, establish exposure limits for each counterparty to
minimize risk and provide counterparty diversification.
Our approach to managing counterparty risk is forward-looking and proactive, allowing us to take risk mitigation actions before
risks become losses. We establish exposure limits for both net fair value and future potential exposure, based on our overall risk
tolerance and ratings-based historical default probabilities. The exposure limits are lower for lower-rated counterparties and for
longer-dated exposures. We use a Monte Carlo simulation technique to assess our potential exposure by tenor, defined at a 95%
confidence level. We monitor and report our exposures to the Treasurer on a monthly basis.
Substantially all of our counterparty exposures are with counterparties that are rated single-A or better. Our guidelines for
counterparty minimum long-term ratings is BBB-. Exceptions to these guidelines require prior approval by management.
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