Ford 2007 Annual Report Download - page 54

52 Ford Motor Company | 2007 Annual Report
Interest Rate Risk. Interest rate risk is the primary market risk to which Ford Credit is exposed and consists principally
of "re-pricing risk" or differences in the re-pricing characteristics of assets and liabilities. An instrument's re-pricing period
is a term used by financial institutions to describe how an interest rate-sensitive instrument responds to changes in
interest rates. It refers to the time it takes an instrument's interest rate to reflect a change in market interest rates. For
fixed-rate instruments, the re-pricing period is equal to the maturity for repayment of the instrument's principal because,
with a fixed interest rate, the principal is considered to re-price only when re-invested in a new instrument. For a floating-
rate instrument, the re-pricing period is the period of time before the interest rate adjusts to the market rate. For instance,
a floating-rate loan whose interest rate is reset to a market index annually on December 31 would have a re-pricing period
of one year on January 1, regardless of the instrument's maturity.
Ford Credit's receivables consist primarily of fixed-rate retail installment sale and lease contracts and floating-rate
wholesale receivables. Fixed-rate retail installment sale and lease contracts are originated principally with maturities
ranging between two and six years and generally require customers to make equal monthly payments over the life of the
contract. Wholesale receivables are originated to finance new and used vehicles held in dealers' inventory and generally
require dealers to pay a floating rate. Ford Credit's funding sources consist primarily of securitizations and short- and
long-term unsecured debt. In the case of unsecured term debt, and in an effort to have funds available throughout the
business cycle, Ford Credit may issue debt with five- to ten-year maturities, which is generally longer than the terms of its
assets. These debt instruments are principally fixed-rate and require fixed and equal interest payments over the life of the
instrument and a single principal payment at maturity.
Ford Credit is exposed to interest rate risk to the extent that a difference exists between the re-pricing profile of its
assets and debt. Specifically, without derivatives, Ford Credit's assets would re-price more quickly than its debt.
Ford Credit's interest rate risk management objective is to maximize its economic value while limiting the impact of
changes in interest rates. Ford Credit achieves this objective by setting an established risk tolerance and staying within
this tolerance through the following risk management process:
Ford Credit determines the sensitivity of the economic value of its portfolio of interest rate-sensitive assets and
liabilities (its economic value) to hypothetical changes in interest rates. Economic value is a measure of the present value
of all future expected cash flows, discounted by market interest rates, and is equal to the present value of interest rate-
sensitive assets minus the present value of interest rate-sensitive liabilities. Ford Credit then enters into interest rate
swaps, to economically convert portions of its floating-rate debt to fixed or its fixed-rate debt to floating, to ensure that the
sensitivity of its economic value falls within an established tolerance. Ford Credit also monitors its pre-tax cash flow
sensitivity over a twelve-month horizon using simulation techniques. This simulation determines the sensitivity of cash
flows associated with the re-pricing characteristics of interest rate-sensitive assets, liabilities and derivatives under various
hypothetical interest rate scenarios including both parallel and non-parallel shifts in the yield curve. This sensitivity
calculation does not take into account any future actions Ford Credit may take to reduce the risk profile that arises from a
change in interest rates. These quantifications of interest rate risk are reported to our Treasurer regularly (either monthly
or quarterly dependent on the market).
The process described above is used to measure and manage the interest rate risk of Ford Credit's operations in the
United States, Canada and the United Kingdom, which together represented approximately 78% of its total on-balance
sheet finance receivables at December 31, 2007. For its other international affiliates, Ford Credit uses a technique
commonly referred to as "gap analysis," to measure re-pricing mismatch. This process uses re-pricing schedules, which
group assets, debt and swaps into discrete time bands based on their re-pricing characteristics. Under this process, Ford
Credit enters into interest rate swaps, which effectively change the re-pricing profile of its debt, to ensure that any re-
pricing mismatch (between assets and liabilities) existing in a particular time band falls within an established tolerance.
Quantitative and Qualitative Disclosures About Market Risk