Ford 2011 Annual Report Download - page 82

Quantitative and Qualitative Disclosures About Market Risk
80 Ford Motor Company | 2011 Annual Report
The net fair value of foreign exchange forward contracts (including adjustments for credit risk) as of
December 31, 2011 was a liability of $236 million compared to a liability of $35 million as of December 31, 2010. The
potential decrease in fair value from a 10% adverse change in the underlying exchange rates, in U.S. dollar terms, would
be about $1.7 billion at December 31, 2011 compared with a decrease of about $350 million as of December 31, 2010.
The increase in potential market risk from the end of last year primarily results from an increase in the amount of foreign
currencies hedged during 2011 as our hedging capacity has increased with improved operating performance.
Commodity Price Risk. Commodity price risk is the possibility that our financial results could be better or worse than
planned because of changes in the prices of commodities used in the production of motor vehicles, such as ferrous
metals (e.g., steel and iron castings), non-ferrous metals (e.g., aluminum), precious metals (e.g., palladium), energy
(e.g., natural gas and electricity), and plastics/resins (e.g., polypropylene). Steel and resins are two of our largest
commodity exposures and are among the most difficult to hedge.
Our normal practice is to use derivative instruments, when available, to hedge the price risk associated with the
purchase of those commodities that we can economically hedge (primarily non-ferrous metals and precious metals). In
our hedging actions, we use derivative instruments commonly used by corporations to reduce commodity price risk (e.g.,
financially settled forward contracts, swaps, and options).
The net fair value of commodity forward contracts (including adjustments for credit risk) as of December 31, 2011 was
a liability of $370 million (which reflects the cumulative mark to market net loss on our hedging contracts for full year
2011), compared to an asset of $63 million as of December 31, 2010. The potential decrease in fair value from a 10%
adverse change in the underlying commodity prices, in U.S. dollar terms, would be about $203 million at
December 31, 2011, compared with a decrease of about $90 million at December 31, 2010. The increase in potential
market risk from the end of last year primarily results from an increase in the amount of commodities hedged during 2011
as our hedging capacity has increased with improved operating performance.
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 portfolios
due to a change in interest rates. Our interest rate sensitivity analysis on the investment portfolios includes cash and
cash equivalents and net marketable securities. At December 31, 2011, we had $22.9 billion in our Automotive
investment portfolios, compared to $20.5 billion at December 31, 2010. We invest the portfolios in securities of various
types and maturities, the value of which are subject to fluctuations in interest rates. The portfolios are classified as trading
portfolios and gains and losses (unrealized and realized) are reported in the statement of operations. 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 investments. In investing our Automotive cash, safety of principal is the primary objective and
risk-adjusted return is the secondary objective.
At any time, a rise in interest rates could have a material adverse impact on the fair value of our portfolios. Assuming
a hypothetical increase in interest rates of one percentage point, the value of our portfolios would be reduced by about
$95 million. This compares to $81 million, as calculated as of December 31, 2010. 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.
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 approach to managing counterparty risk is forward-looking and proactive, allowing us to take risk mitigation
actions before risks become losses. Exposure limits are established based on our overall risk tolerance and estimated
loss projections which are calculated from ratings-based historical default probabilities. The exposure limits are lower for
lower-rated counterparties and for longer-dated exposures. Our exposures are monitored on a regular basis and included
in periodic reports to our Treasurer.