Ford 2004 Annual Report Download - page 54

Counterparty Risk. Counterparty risk relates to the loss we could incur if an obligor or counterparty defaulted on an investment
or a derivative contract. We enter into master agreements with counterparties that allow netting of certain exposures in order
to manage this risk. Exposures primarily relate to investments in fixed-income instruments and derivative contracts used for
managing interest rate, foreign currency exchange rate and commodity price risk. We, together with Ford Credit, establish
exposure limits for each counterparty to minimize risk and provide counterparty diversification. Our exposures are monitored
on a regular basis and are included in monthly reporting to the Treasurer.
Our approach to managing counterparty risk is forward-looking and proactive, allowing us to take risk mitigation actions. We
establish exposure limits for both mark-to-market and future potential exposure, based on our overall risk tolerance and ratings-based
historical default probabilities. The exposure limits are lower for lower-rated counterparties and for longer-dated exposures. We use a
Monte Carlo simulation technique to assess our potential exposure by tenor, defined at a 95% confidence level.
Substantially all of our counterparty and obligor exposures are with counterparties and obligors that are rated single-A or better.
FORD CREDIT MARKET RISKS
Overview. Ford Credit is exposed to a variety of risks in the normal course of its business activities. In addition to counterparty
risk discussed above, Ford Credit is subject to the following additional types of risks that it seeks to identify, assess, monitor and
manage, in accordance with defined policies and procedures:
• Market risk – the possibility that changes in interest and currency exchange rates or prices will have an adverse impact on
operating results;
• Credit risk – the possibility of loss from a customer’s failure to make payments according to contract terms;
• Residual risk – the possibility that the actual proceeds Ford Credit receives at lease termination will be lower than its
projections or return rates will be higher than its projections; and,
• Liquidity risk – the possibility that Ford Credit may be unable to meet all current and future obligations in a timely manner.
Each form of risk is uniquely managed in the context of its contribution to Ford Credit’s overall global risk. Business decisions
are evaluated on a risk-adjusted basis and products are priced consistent with these risks. Credit and residual risks are
discussed above in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the
caption “Critical Accounting Estimates” and liquidity risk is discussed above in “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” under the caption “Liquidity and Capital Resources – Financial Services Sector
– Ford Credit”. A discussion of Ford Credit’s market risks is included below.
Foreign Currency Risk. To meet funding objectives, Ford Credit issues debt or, for its international affiliates, draws on local
credit lines in a variety of currencies. Ford Credit faces exposure to currency exchange rate changes if a mismatch exists
between the currency of its receivables and the currency of the debt funding those receivables. When possible, receivables
are funded with debt in the same currency, minimizing exposure to exchange rate movements. When a different currency is
used, Ford Credit seeks to minimize the impact of currency exchange rates on operating results by executing foreign currency
derivatives. These derivatives convert substantially all of its foreign currency debt obligations to the local country currency of the
receivables. As a result, Ford Credit’s market risk exposure relating to currency exchange rates is believed to be immaterial.
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 31st would have a re-pricing period of one year on January 1st,
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. Ford Credit’s
funding sources consist primarily of short- and long-term unsecured debt and sales of receivables in securitizations. 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.
5 2
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK