FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS

Financial instruments include cash and cash equivalents, marketable securities, accounts receivable and payable, debt instruments and derivatives.

Changes in exchange rates and interest rates create exposure to market risk. Certain derivative financial instruments are used when available on a cost-effective basis to hedge the underlying economic exposure. These instruments qualify as cash flow, net investment and fair value hedges upon meeting certain criteria, including effectiveness of offsetting hedged exposures. Changes in fair value of derivatives that do not qualify for hedge accounting are recognized in earnings as they occur. Derivative financial instruments are not used for trading purposes.

Financial instruments are subject to counterparty credit risk which is considered as part of the overall fair value measurement. Counterparty credit risk is monitored on an ongoing basis and mitigated by limiting amounts outstanding with any individual counterparty, utilizing conventional derivative financial instruments and only entering into agreements with counterparties that meet high credit quality standards. The consolidated financial statements would not be materially impacted if any counterparty failed to perform according to the terms of its agreement. Collateral is not required by any party whether derivatives are in an asset or liability position under the terms of the agreements.

Fair Value Measurements – The fair values of financial instruments are classified into one of the following categories:

Level 1 inputs utilize non-binding quoted prices (unadjusted) in active markets accessible at the measurement date for identical assets or liabilities. The fair value hierarchy provides the highest priority to Level 1 inputs.

Level 2 inputs utilize observable prices for similar instruments, non-binding quoted prices for identical or similar instruments in non-active markets, and other observable inputs corroborated by market data for substantially the full term of the assets or liabilities. These instruments include corporate debt securities, certificates of deposit, money market funds, foreign currency forward contracts, interest rate swap contracts, equity funds, fixed income funds and long-term debt. Additionally, certain corporate debt securities utilize a third-party matrix pricing model using significant inputs corroborated by market data for substantially the full term of the assets. Equity and fixed income funds are primarily invested in publicly traded securities valued at the respective net asset value of the underlying investments. There were no significant unfunded commitments or restrictions on redemptions related to equity and fixed income funds as of December 31, 2014. Level 2 derivative instruments are valued using London Interbank Offered Rate (LIBOR) yield curves, less credit valuation adjustments, and observable forward foreign exchange rates at the reporting date. Valuations of derivative contracts may fluctuate considerably from volatility in underlying foreign currencies and underlying interest rates driven by market conditions and the duration of the contract. Credit adjustment volatility may have a significant impact on the valuation of interest rate swap contracts resulting from changes in counterparty credit ratings and credit default swap spreads.

Level 3 unobservable inputs are used when little or no market data is available. The fair value of written options to sell the assets of certain businesses (see “—Note 3. Alliances” for further discussion) is based on an option pricing methodology that considers revenue and profitability projections, volatility, discount rates, and potential exercise price assumptions. The fair value of contingent consideration related to an acquisition was estimated utilizing a model that considered the probability of achieving each milestone and discount rates.

Financial assets and liabilities measured at fair value on a recurring basis are summarized below:



	December 31, 2014											December 31, 2013
Dollars in Millions	Level 1		Level 2			Level 3			Total			Level 1		Level 2			Level 3			Total
Cash and cash equivalents - Money market and other securities	$	—	$	5,051		$	—		$	5,051		$	—	$	3,201		$	—		$	3,201
Marketable securities
Certificates of deposit	—		896			—			896			—		122			—			122
Corporate debt securities	—		5,259			—			5,259			—		4,432			—			4,432
Equity funds	—		94			—			94			—		74			—			74
Fixed income funds	—		11			—			11			—		46			—			46
Auction Rate Securities (ARS)	—		—			12			12			—		—			12			12
Derivative assets:
Interest rate swap contracts	—		46			—			46			—		64			—			64
Foreign currency forward contracts	—		118			—			118			—		50			—			50
Equity investments	36		—			—			36			—		—			—			—
Derivative liabilities:
Interest rate swap contracts	—		(3		)	—			(3		)	—		(27		)	—			(27		)
Foreign currency forward contracts	—		—			—			—			—		(35		)	—			(35		)
Written option liabilities	—		—			(198		)	(198		)	—		—			(162		)	(162		)
Contingent consideration liability	—		—			(8		)	(8		)	—		—			(8		)	(8		)

The following table summarizes the activity the financial assets utilizing Level 3 fair value measurements:



	2014								2013
Dollars in Millions	ARS		Written option liabilities			Contingent consideration liability			ARS and FRS^(a)			Written option liabilities			Contingent consideration liability
Fair value at January 1	$	12	$	(162	)	$	(8	)	$	31		$	(18	)	$	(8	)
Additions from new alliances	—		—			—			—			(144		)	—
Unrealized gains	—		—			—			1			—			—
Sales	—		—			—			(20		)	—			—
Changes in fair value	—		(36		)	—			—			—			—
Fair value at December 31	$	12	$	(198	)	$	(8	)	$	12		$	(162	)	$	(8	)


(a)	Floating Rate Securities

Available-for-sale Securities

The following table summarizes available-for-sale securities:



Dollars in Millions	Amortized Cost		Gross Unrealized Gain in Accumulated OCI		Gross Unrealized Loss in Accumulated OCI			Fair Value
Dollars in Millions	Amortized Cost		Gross Unrealized Gain in Accumulated OCI		Gross Unrealized Loss in Accumulated OCI			Fair Value
December 31, 2014
Certificates of deposit	$	896	$	—	$	—		$	896
Corporate debt securities	5,237		30		(8		)	5,259
ARS	9		3		—			12
Equity investments	14		22		—			36
Total	$	6,156	$	55	$	(8	)	$	6,203

December 31, 2013
Certificates of deposit	$	122	$	—	$	—		$	122
Corporate debt securities	4,401		44		(13		)	4,432
ARS	9		3		—			12
Total	$	4,532	$	47	$	(13	)	$	4,566

Available-for-sale securities included in current marketable securities were $1,759 million at December 31, 2014 and $819 million at December 31, 2013. Non-current available-for-sale corporate debt securities mature within five years at December 31, 2014, except for ARS. Equity investments of $36 million were included in other assets at December 31, 2014.

Fair Value Option for Financial Assets

Investments in equity and fixed income funds offsetting changes in fair value of certain employee retirement benefits were included in current marketable securities. Investment income resulting from changes in fair value was not significant.

Qualifying Hedges

The following summarizes the fair value of outstanding derivatives:



		December 31, 2014					December 31, 2013
Dollars in Millions	Balance Sheet Location	Notional		Fair Value			Notional		Fair Value
Derivatives designated as hedging instruments:
Interest rate swap contracts	Other assets	$	847	$	46		$	673	$	64
Interest rate swap contracts	Other liabilities	1,050		(3		)	1,950		(27		)
Foreign currency forward contracts	Prepaid expenses and other	1,323		106			301		44
Foreign currency forward contracts	Other assets	100		12			100		6
Foreign currency forward contracts	Accrued expenses	—		—			704		(31		)
Foreign currency forward contracts	Other liabilities	—		—			263		(4		)

Cash Flow Hedges — Foreign currency forward contracts are primarily utilized to hedge forecasted intercompany inventory purchase transactions in certain foreign currencies. The contracts are designated as cash flow hedges with the effective portion of changes in fair value reported in accumulated OCI and recognized in earnings when the hedged item affects earnings. The net gains are expected to be reclassified to cost of products sold within the next two years. The notional amount of outstanding foreign currency forward contracts was primarily attributed to the euro ($536 million) and Japanese yen ($636 million) at December 31, 2014. The fair value of a foreign currency forward contract attributed to the Japanese yen (notional amount of $330 million) not designated as a cash flow hedge was $7 million and was included in prepaid expenses and other at December 31, 2014.

Cash flow hedge accounting is discontinued when the forecasted transaction is no longer probable of occurring within 60 days after the originally forecasted date or when the hedge is no longer effective. Assessments to determine whether derivatives designated as qualifying hedges are highly effective in offsetting changes in the cash flows of hedged items are performed at inception and on a quarterly basis. The earnings impact related to discontinued cash flow hedges and hedge ineffectiveness was not significant during all periods presented.

Net Investment Hedges — Non-U.S. dollar borrowings of €541 million ($662 million) are designated to hedge the foreign currency exposures of the net investment in certain foreign affiliates. These borrowings are designated as net investment hedges and recognized in long term debt. The effective portion of foreign exchange gains or losses on the remeasurement of the debt is recognized in the foreign currency translation component of accumulated OCI with the related offset in long term debt.

Fair Value Hedges — Fixed-to-floating interest rate swap contracts are designated as fair value hedges used as an interest rate risk management strategy to create an appropriate balance of fixed and floating rate debt. The contracts and underlying debt for the hedged benchmark risk are recorded at fair value. The effective interest rate for the contracts is one-month LIBOR (0.17% as of December 31, 2014) plus an interest rate spread ranging from (0.8)% to 2.9%. When the underlying swap is terminated prior to maturity, the fair value basis adjustment to the underlying debt instrument is amortized as a reduction to interest expense over the remaining life of the debt.

The notional amount of fixed-to-floating interest rate swap contracts executed was $200 million in 2014 and $2.1 billion in 2013. The notional amount of fixed-to-floating interest rate swap contracts terminated was $426 million in 2014, generating proceeds of $119 million (including accrued interest of $10 million). Additional contracts were terminated in connection with debt redemptions in 2014 and 2012.

Debt Obligations

Short-term borrowings were $590 million and $359 million at December 31, 2014 and 2013, respectively, consisting primarily of bank overdrafts.

Long-term debt and the current portion of long-term debt includes:



	December 31,
Dollars in Millions	2014			2013
Principal Value:
4.375% Euro Notes due 2016	$	611		$	684
0.875% Notes due 2017	750			750
5.450% Notes due 2018	—			582
1.750% Notes due 2019	500			500
4.625% Euro Notes due 2021	611			684
2.000% Notes due 2022	750			750
7.150% Debentures due 2023	304			304
3.250% Notes due 2023	500			500
6.800% Debentures due 2026	330			330
5.875% Notes due 2036	625			625
6.125% Notes due 2038	480			480
3.250% Notes due 2042	500			500
4.500% Notes due 2044	500			500
6.880% Debentures due 2097	260			260
0% - 5.75% Other - maturing 2016 - 2030	83			144
Subtotal	6,804			7,593

Adjustments to Principal Value:
Fair value of interest rate swap contracts	43			37
Unamortized basis adjustment from swap terminations	454			442
Unamortized bond discounts	(59		)	(64		)
Total	$	7,242		$	8,008

Current portion of long-term debt^(a)	$	—		$	27
Long-term debt	7,242			7,981


(a)	Included in liabilities related to assets held-for-sale at December 31, 2013.

The fair value of long-term debt was $8,045 million and $8,487 million at December 31, 2014 and 2013, respectively, and was estimated based upon the quoted market prices for the same or similar debt instruments. The fair value of short-term borrowings approximates the carrying value due to the short maturities of the debt instruments.

Floating Rate Convertible Senior Debentures of $18 million due 2023 are redeemable by the holders at par on September 15, 2018 or if a fundamental change in ownership occurs and are callable at par at any time by BMS. The Debentures have a current conversion price of $39.58, equal to a conversion rate of 25.2623 shares for each $1,000 principal amount, subject to certain anti-dilutive adjustments.

Senior unsecured notes issued in registered public offerings were $1.5 billion in 2013 and $2.0 billion in 2012. Interest on the notes will be paid semi-annually. The notes rank equally in right of payment with all of BMS’s existing and future senior unsecured indebtedness and are redeemable by BMS in whole or in part, at any time at a predetermined redemption price.

The 5.25% Notes with a principal amount of $597 million matured and was repaid in 2013. Substantially all of the $2.0 billion debt obligations assumed in the acquisition of Amylin were repaid in 2012, including a promissory note with Lilly with respect to a revenue sharing obligation and Amylin senior notes due 2014.

There were no debt redemptions in 2013. Debt redemption activity for 2014 and 2012, including repayment of the Amylin debt obligations, was as follows:



Dollars in Millions	2014			2012
Principal amount	$	582		$	2,052
Carrying value	633			2,081
Redemption price	676			2,108
Notional amount of interest rate swap contracts terminated	500			6
Swap termination proceeds/(payments)	(4		)	2
Total loss	45			27

Interest payments were $238 million in 2014, $268 million in 2013 and $241 million in 2012 net of amounts received from interest rate swap contracts.

Two separate $1.5 billion five-year revolving credit facilities are maintained from a syndicate of lenders. The facilities provide for customary terms and conditions with no financial covenants and are extendable on any anniversary date with the consent of the lenders. No borrowings were outstanding under either revolving credit facility at December 31, 2014 or 2013.

Financial guarantees provided in the form of stand-by letters of credit and performance bonds were $725 million at December 31, 2014. Stand-by letters of credit are issued through financial institutions in support of guarantees for various obligations. Performance bonds are issued to support a range of ongoing operating activities, including sale of products to hospitals and foreign ministries of health, bonds for customs, duties and value added tax and guarantees related to miscellaneous legal actions. A significant majority of the outstanding financial guarantees will expire within the year and are not expected to be funded.