International Paper 2012 Annual Report Download - page 103

Fair Value Measurements
International Paper’s financial assets and liabilities
that are recorded at fair value consist of derivative
contracts, including interest rate swaps, foreign cur-
rency forward contracts, and other financial instru-
ments that are used to hedge exposures to interest
rate, commodity and currency risks. In addition, a
consolidated subsidiary of International Paper has an
embedded derivative. For these financial instruments
and the embedded derivative, fair value is
determined at each balance sheet date using an
income approach.
The guidance for fair value measurements and dis-
closures sets out a fair value hierarchy that groups
fair value measurement inputs into the following
three classifications:
Level 1: Quoted market prices in active markets for
identical assets or liabilities.
Level 2: Observable market-based inputs other than
quoted prices included within Level 1 that are
observable for the asset or liability, either directly or
indirectly.
Level 3: Unobservable inputs for the asset or liability
reflecting the reporting entity’s own assumptions or
external inputs from inactive markets.
Transfers between levels are recognized at the end
of the reporting period. All of International Paper’s
derivative fair value measurements use Level 2
inputs.
Below is a description of the valuation calculation
and the inputs used for each class of contract:
Interest Rate Contracts
Interest rate contracts are valued using swap curves
obtained from an independent market data provider.
The market value of each contract is the sum of the
fair value of all future interest payments between the
contract counterparties, discounted to present value.
The fair value of the future interest payments is
determined by comparing the contract rate to the
derived forward interest rate and present valued
using the appropriate derived interest rate curve.
Fuel Oil Contracts
Fuel oil contracts are valued using the average of
two forward fuel oil curves as quoted by third par-
ties. The fair value of each contract is determined by
comparing the strike price to the forward price of the
corresponding fuel oil contract and present valued
using the appropriate interest rate curve.
Natural Gas Contracts
Natural gas contracts are traded over-the-counter
and settled using the NYMEX last day settle price;
therefore, forward contracts are valued using the
closing prices of the NYMEX natural gas future con-
tracts. The fair value of each contract is determined
by comparing the strike price to the closing price of
the corresponding natural gas future contract and
present valued using the appropriate interest rate
curve.
Foreign Exchange Contracts
Foreign currency forward contracts are valued using
foreign currency forward and interest rate curves
obtained from an independent market data provider.
The fair value of each contract is determined by
comparing the contract rate to the forward rate. The
fair value is present valued using the applicable
interest rate from an independent market data pro-
vider.
Embedded Derivative
Embedded derivatives are valued using a hypo-
thetical interest rate derivative with identical terms.
The hypothetical interest rate derivative contracts are
fair valued as described above under Interest Rate
Contracts.
Since the volume and level of activity of the markets
that each of the above contracts are traded in has
been normal, the fair value calculations have not
been adjusted for inactive markets or disorderly
transactions.
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