Ford 2006 Annual Report Download - page 91

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89
Notes to the Financial Statements
89
NOTE 22. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES (Continued)
the value of these derivative instruments, excluding the ineffective portion of the hedge, were included in OCI as a foreign
currency translation adjustment. The exchange of cash associated with these derivative transactions is reported as net
cash flows from operating activities in our statements of cash flows.
Derivatives not designated as hedging instruments. Some derivatives do not qualify for hedge accounting treatment or
we elect not to apply hedge accounting. We report changes in the fair value of these derivatives through Automotive cost
of sales or Automotive interest income and other non-operating income/(expense),net depending on the underlying
exposure. The earnings impact primarily relates to the revaluation of foreign currency derivatives and changes in fair
value of commodity derivatives and warrants. The exchange of cash associated with these derivative transactions is
recorded as net cash flows from investing activities in our statements of cash flows.
Financial Services Sector
Ford Credit's overall risk management objective is to maximize economic value while limiting the effect of changes in
foreign currencies and interest rates. Ford Credit faces exposure to currency exchange rates if a mismatch exists
between the currency of its receivables and the currency of the debt funding those receivables. Ford Credit executes
cross-currency swaps and foreign currency forwards to convert substantially all of the foreign currency debt obligations to
the local currency of the receivables. Interest rate swaps are used to manage exposure to re-pricing risk, which arises
when assets and the debt funding those assets have different re-pricing periods that consequently respond differently to
interest rate changes. Regardless of hedge accounting treatment, derivative positions are used only to manage identified
exposures.
Fair Value Hedges. Ford Credit uses certain derivatives to reduce the risk of changes in the fair value of liabilities. We
designate receive-fixed, pay-float interest rate swaps as hedges of existing fixed-rate debt. The risk being hedged is the
risk of changes in the fair value of the hedged item attributable to changes in the benchmark interest rate. For certain
interest rate swaps we use the dollar-offset method to assess hedge effectiveness. Hedge ineffectiveness is the
difference between the change in fair value of the entire derivative instrument and the change in fair value of the hedged
item. Ineffectiveness is recorded directly in earnings. The notional balances for these highly effective interest rate swaps
were $1.1 billion, $1.8 billion, and $13.1 billion at December 31, 2006, 2005, and 2004, respectively. Other interest rate
swaps meet the specific criteria to assume no ineffectiveness in the hedge relationship. These interest rate swaps had
notional balances of $0, $3.8 billion, and $5.6 billion at December 31, 2006, 2005, and 2004, respectively.
Cash Flow Hedges. Ford Credit has used certain derivatives to reduce the risk of the variability of expected future
cash flows. We designated receive-float, pay-fixed interest rate swaps as hedges of existing floating rate debt. The risk
being hedged was the risk of changes in the cash flows of the hedged item attributable to changes in the benchmark
interest rate. We used the change in variable cash flows method to measure hedge ineffectiveness, which was the
difference between the change in the fair value of the float leg of the swap and the change in fair value of the hedged
item. Hedge ineffectiveness was recorded directly in earnings. Ford Credit had notional balances of $0, $0, and
$17.8 billion in receive-float, pay-fixed interest rates swaps classified as cash flow hedges at December 31, 2006, 2005,
and 2004, respectively.
Net Investment Hedges. Ford Credit has used foreign currency forward exchange contracts and options to hedge the
net assets of certain foreign entities to offset the translation and economic exposures related to its investment in these
entities. We assessed effectiveness based upon a comparison of the hedge with the beginning balance of the net
investment level hedged, with subsequent quarterly tests based upon changes in spot rates to determine the effective
portion of the hedge. Ford Credit had notional balances of $0, $0, and $1.6 billion in foreign currency forwards and
foreign currency options classified as net investment hedges at December 31, 2006, 2005, and 2004, respectively.
Changes in the value of these derivative instruments, excluding the ineffective portion of the hedge, were included in OCI
as a foreign currency translation adjustment.