Alcoa 2014 Annual Report Download - page 175

(observable inputs) and (ii) an entity’s own assumptions about market participant assumptions developed based on the
best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad
levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities
(Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are
described below:
• Level 1—Unadjusted quoted prices in active markets that are accessible at the measurement date for
identical, unrestricted assets or liabilities.
• Level 2—Inputs other than quoted prices included within Level 1 that are observable for the asset or liability,
either directly or indirectly, including quoted prices for similar assets or liabilities in active markets; quoted
prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted
prices that are observable for the asset or liability (e.g., interest rates); and inputs that are derived principally
from or corroborated by observable market data by correlation or other means.
• Level 3—Inputs that are both significant to the fair value measurement and unobservable.
Derivatives. Alcoa is exposed to certain risks relating to its ongoing business operations, including financial, market,
political, and economic risks. The following discussion provides information regarding Alcoa’s exposure to the risks of
changing commodity prices, interest rates, and foreign currency exchange rates.
Alcoa’s commodity and derivative activities are subject to the management, direction, and control of the Strategic Risk
Management Committee (SRMC), which is composed of the chief executive officer, the chief financial officer, and
other officers and employees that the chief executive officer selects. The SRMC meets on a periodic basis to review
derivative positions and strategy and reports to Alcoa’s Board of Directors on the scope of its activities.
The aluminum, energy, interest rate, and foreign exchange contracts are held for purposes other than trading. They are
used primarily to mitigate uncertainty and volatility, and to cover underlying exposures. Alcoa is not involved in
trading activities for energy, weather derivatives, or other nonexchange commodity trading activities.
A number of Alcoa’s aluminum, energy, and foreign exchange contracts are classified as Level 1 and an interest rate
contract is classified as Level 2 under the fair value hierarchy. These energy, foreign exchange, and interest rate
contracts are not material to Alcoa’s Consolidated Financial Statements for all periods presented except as follows for
two foreign exchange contracts. Alcoa had a forward contract to purchase $53 (C$58) to mitigate the foreign currency
risk related to a Canadian-denominated loan, which was repaid on August 31, 2014 upon maturity. The forward
contract expired on August 5, 2014 and a gain of $1 was recognized in 2014. Also, in December 2013, Alcoa entered
into a forward contract to purchase $231 (R$543) to mitigate the foreign currency risk associated with a potential
future transaction denominated in Brazilian reais. This contract expired on March 31, 2014 and a loss of $4 was
recognized in 2014.
For the aluminum contracts classified as Level 1, the total fair value of derivatives recorded as assets and liabilities
were $2 and $31 and $4 and $45 at December 31, 2014 and 2013, respectively. These contracts were entered into to
either hedge forecasted sales or purchases of aluminum in order to manage the associated aluminum price risk. Certain
of these contracts are designated as hedging instruments, either fair value or cash flow, and the remaining are not
designated as such. Combined, Alcoa recognized a net loss of $15, a net gain of $4, and a net gain of $88 in Sales
related to these aluminum contracts in 2014, 2013, and 2012, respectively. Additionally, for the contracts designated as
cash flow hedges, Alcoa recognized an unrealized gain of $9 and $40 in Other comprehensive loss in 2013 and 2012,
respectively.
In addition to the Level 1 and 2 derivative instruments described above, Alcoa has nine derivative instruments
classified as Level 3 under the fair value hierarchy. These instruments are composed of seven embedded aluminum
derivatives, an energy contract, and an embedded credit derivative, all of which relate to energy supply contracts
associated with seven smelters and three refineries. Five of the embedded aluminum derivatives and the energy
contract were designated as cash flow hedging instruments and the remaining derivatives were not designated as
hedging instruments.
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