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80 Ford Motor Company | 2012 Annual Report
FORD MOTOR COMPANY AND SUBSIDIARIES
NOTES TO THE FINANCIAL STATEMENTS
NOTE 4. FAIR VALUE MEASUREMENTS (Continued)
Derivative Financial Instruments. Our derivatives are over-the-counter customized derivative transactions and are not
exchange traded. We estimate the fair value of these instruments using industry-standard valuation models such as a
discounted cash flow. These models project future cash flows and discount the future amounts to a present value using
market-based expectations for interest rates, foreign exchange rates, commodity prices, and the contractual terms of the
derivative instruments. The discount rate used is the relevant interbank deposit rate (e.g., LIBOR) plus an adjustment for
non-performance risk. The adjustment reflects the full credit default swap ("CDS") spread applied to a net exposure, by
counterparty, considering the master netting agreements and posted collateral. We use our counterparty's CDS spread
when we are in a net asset position and our own CDS spread when we are in a net liability position. In certain cases,
market data are not available and we use broker quotes and models (e.g., Black Scholes) to determine fair value. This
includes situations where there is illiquidity for a particular currency or commodity or for longer-dated instruments.
Ford Credit's two Ford Upgrade Exchange Linked securitization transactions ("FUEL Notes") had derivative features
that included a mandatory exchange to Ford Credit unsecured notes when Ford Credit's senior unsecured debt received
two investment grade credit ratings among Fitch, Moody's, and S&P, and a make-whole provision. Ford Credit estimated
the fair value of these features by comparing the fair value of the FUEL Notes to the value of a hypothetical debt
instrument without these features. In the second quarter of 2012, Ford Credit received two investment grade credit
ratings, thereby triggering the mandatory exchange feature and the FUEL Notes derivatives were extinguished.
Finance Receivables. We measure finance receivables at fair value for purposes of disclosure (see Note 7) using
internal valuation models. These models project future cash flows of financing contracts based on scheduled contract
payments (including principal and interest). The projected cash flows are discounted to present value based on
assumptions regarding credit losses, pre-payment speed, and applicable spreads to approximate current rates. Our
assumptions regarding pre-payment speed and credit losses are based on historical performance. The fair value of
finance receivables is categorized within Level 3 of the hierarchy.
On a nonrecurring basis, when retail contracts are greater than 120 days past due or deemed to be uncollectible, or if
individual dealer loans are probable of foreclosure, we use the fair value of collateral, adjusted for estimated costs to sell,
to determine the fair value adjustment to our receivables. The collateral for retail receivables is the vehicle financed, and
for dealer loans is real estate or other property.
The fair value measurements for retail receivables are based on the number of contracts multiplied by the loss
severity and the probability of default ("POD") percentage, or the outstanding receivable balances multiplied by the
average recovery value ("ARV") percentage to determine the fair value adjustment.
The fair value measurements for dealer loans are based on an assessment of the estimated fair value of collateral.
The assessment is performed by reviewing various appraisals, which include total adjusted appraised value of land and
improvements, alternate use appraised value, broker's opinion of value, and purchase offers. The fair value adjustment is
determined by comparing the net carrying value of the dealer loan and the estimated fair value of collateral.
Debt. We measure debt at fair value for purposes of disclosure (see Note 17) using quoted prices for our own debt
with approximately the same remaining maturities, where possible. Where quoted prices are not available, we estimate
fair value using discounted cash flows and market-based expectations for interest rates, credit risk, and the contractual
terms of the debt instruments. For certain short-term debt with an original maturity date of one year or less, we assume
that book value is a reasonable approximation of the debt's fair value. The fair value of debt is categorized within Level 2
of the hierarchy.