Ford 2006 Annual Report Download - page 90
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Notes to the Financial Statements
88
NOTE 21. OPERATING CASH FLOWS (Continued)
Cash paid/(received) for interest and income taxes for continuing operations was as follows (in millions):
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NOTE 22. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
Our operations are exposed to global market risks, including the effect of changes in foreign currency exchange rates,
certain commodity prices and interest rates. The objective of our risk management program is to manage the financial
and operational exposure arising from these risks by offsetting gains and losses on the underlying exposures with gains
and losses on derivatives used to hedge them. We document our hedging objectives, practices, procedures, and
accounting treatment. In addition, we review our hedging program and our derivative positions, as well as our strategy, on
a regular basis.
Our use of derivatives to manage market risk results in the risk of a counterparty defaulting on a derivative contract.
We establish exposure limits for each counterparty to minimize this risk and provide counterparty diversification. We also
enter into master netting agreements with counterparties that usually allow for netting of certain exposures. Substantially
all of our counterparties have long-term debt ratings of single-A or better. The aggregate fair value of derivative
instruments in asset positions on December 31, 2006, is $5.2 billion, and represents the maximum loss that would be
recognized at the reporting date if all counterparties failed to perform as contracted.
Hedge Accounting Designations
We have elected to apply hedge accounting to certain derivatives. Derivatives that receive designated hedge
accounting treatment are documented and evaluated for effectiveness in accordance with our documentation. Some
derivatives do not qualify for hedge accounting; for others, we elect not to apply hedge accounting treatment. We have
elected to apply the normal purchase and normal sales classification to all physical supply contracts that are entered into
for the purpose of procuring commodities to be used in production within a reasonable time during the normal course of
our business.
Automotive Sector
Cash Flow Hedges. We use forward and option contracts to manage our exposure to foreign currency exchange and
commodity price risks. We apply the critical terms method of assessing effectiveness for derivatives designated as
hedging forecasted transactions. The effective portion of changes in the fair value of cash flow hedges is deferred in
Accumulated other comprehensive income/(loss) ("OCI") and is recognized in Automotive cost of sales when the hedged
item affects earnings. An amount is also reclassified from OCI and recognized in earnings if it becomes probable that the
original forecasted transaction will not occur. Our cash flow hedges mature within three years or less. The exchange of
cash associated with these derivative transactions is reported as net cash flows from operating activities in our statements
of cash flows.
Net Investment Hedges. We use foreign currency forward exchange contracts to hedge the net assets of certain
foreign entities to offset the translation and economic exposures related to our investment in these entities. We assess
effectiveness based upon a comparison of the hedge with the beginning balance of the net investment level hedged, with
subsequent quarterly tests based upon changes in spot rates to determine the effective portion of the hedge. Changes in