Ford 2006 Annual Report Download - page 46
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Foreign Currency Risk. Foreign currency risk is the possibility that our financial results could be better or worse than
planned because of changes in foreign currency exchange rates. Accordingly, we use derivative instruments to hedge
our economic exposure with respect to forecasted revenues and costs, assets, liabilities, investments in foreign
operations, and firm commitments denominated in foreign currencies. In our hedging actions, we use primarily
instruments commonly used by corporations to reduce foreign exchange risk (e.g., forward contracts and options).
The net fair value of financial instruments with exposure to cash flow foreign currency risk was an asset of $705 million
as of December 31, 2006 compared to a net fair value liability of $421 million as of December 31, 2005. The increase in
fair value primarily reflects mark-to-market adjustments resulting from the weakening of the U.S. dollar against the euro,
the British pound and the Swedish krona. The potential decrease in fair value for such financial instruments, assuming a
10% adverse change in quoted foreign currency exchange rates, would be $2.1 billion and $1.6 billion at
December 31, 2006 and 2005, 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, 2006 and 2005 was
$750 million and $664 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 about $200 million at both
December 31, 2006 and 2005.
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, net marketable and loaned securities and VEBA assets. At December 31, 2006, we had $37.5 billion
(including total VEBA assets of $4.9 billion) in our Automotive investment portfolio, compared to $25.1 billion at
December 31, 2005. 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 Stockholders' Equity in Accumulated other comprehensive income/(loss). 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, 2006, the value of our trading portfolio was $36.6 billion, which is $14 billion
higher than December 31, 2005. The value of our available-for-sale portfolio was about $900 million, which is $1.6 billion
lower than December 31, 2005.
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 $121 million and $12 million, respectively. This compares to $91 million and
$28 million, respectively, as calculated as of December 31, 2005. 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.
Quantitative and Qualitative Disclosures About Market Risk