Fair value disclosures

A. Fair value measurements

The guidance on fair value measurements defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants. This guidance also specifies a fair value hierarchy based upon the observability of inputs used in valuation techniques. Observable inputs (highest level) reflect market data obtained from independent sources, while unobservable inputs (lowest level) reflect internally developed market assumptions. In accordance with this guidance, fair value measurements are classified under the following hierarchy:


•	Level 1 – Quoted prices for identical instruments in active markets.


•	Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs or significant value-drivers are observable in active markets.


•	Level 3 – Model-derived valuations in which one or more significant inputs or significant value-drivers are unobservable.

When available, we use quoted market prices to determine fair value, and we classify such measurements within Level 1. In some cases where market prices are not available, we make use of observable market based inputs to calculate fair value, in which case the measurements are classified within Level 2. If quoted or observable market prices are not available, fair value is based upon valuations in which one or more significant inputs are unobservable, including internally developed models that use, where possible, current market-based parameters such as interest rates, yield curves and currency rates. These measurements are classified within Level 3.

Fair value measurements are classified according to the lowest level input or value-driver that is significant to the valuation. A measurement may therefore be classified within Level 3 even though there may be significant inputs that are readily observable.

Fair value measurement includes the consideration of nonperformance risk. Nonperformance risk refers to the risk that an obligation (either by a counterparty or Caterpillar) will not be fulfilled. For financial assets traded in an active market (Level 1 and certain Level 2), the nonperformance risk is included in the market price. For certain other financial assets and liabilities (certain Level 2 and Level 3), our fair value calculations have been adjusted accordingly.

Investments in debt and equity securities

Investments in certain debt and equity securities, primarily at Insurance Services, have been classified as available-for-sale and recorded at fair value. Fair values for our U.S. treasury bonds and large capitalization value and smaller company growth equity securities are based upon valuations for identical instruments in active markets. Fair values for other government bonds, corporate bonds and mortgage-backed debt securities are based upon models that take into consideration such market-based factors as recent sales, risk-free yield curves and prices of similarly rated bonds.

In addition, Insurance Services has an equity investment in a real estate investment trust (REIT) which is recorded at fair value based on the net asset value (NAV) of the investment.

See Note 8 for additional information on our investments in debt and equity securities.

Derivative financial instruments

The fair value of interest rate contracts is primarily based on models that utilize the appropriate market-based forward swap curves and zero-coupon interest rates to determine discounted cash flows. The fair value of foreign currency and commodity forward, option and cross currency contracts is based on a valuation model that discounts cash flows resulting from the differential between the contract price and the market-based forward rate.

Assets and liabilities measured on a recurring basis at fair value, primarily related to Financial Products, included in our Consolidated Statement of Financial Position as of March 31, 2017 and December 31, 2016 are summarized below:



	March 31, 2017
(Millions of dollars)	Level 1		Level 2		Level 3		Total Assets / Liabilities, at Fair Value
Assets
Available-for-sale securities
Government debt
U.S. treasury bonds	$	9	$	—	$	—	$	9
Other U.S. and non-U.S. government bonds	—		58		—		58
Corporate bonds
Corporate bonds	—		482		—		482
Asset-backed securities	—		88		—		88
Mortgage-backed debt securities
U.S. governmental agency	—		212		—		212
Residential	—		9		—		9
Commercial	—		31		—		31
Equity securities
Large capitalization value	325		—		—		325
Smaller company growth	60		—		—		60
Total available-for-sale securities	394		880		—		1,274
REIT	—		—		88		88
Total Assets	$	394	$	880	$	88	$	1,362
Liabilities
Derivative financial instruments, net	—		21		—		21
Total Liabilities	$	—	$	21	$	—	$	21



	December 31, 2016
(Millions of dollars)	Level 1		Level 2		Level 3		Total Assets / Liabilities, at Fair Value
Assets
Available-for-sale securities
Government debt
U.S. treasury bonds	$	9	$	—	$	—	$	9
Other U.S. and non-U.S. government bonds	—		60		—		60
Corporate bonds
Corporate bonds	—		492		—		492
Asset-backed securities	—		90		—		90
Mortgage-backed debt securities
U.S. governmental agency	—		223		—		223
Residential	—		10		—		10
Commercial	—		36		—		36
Equity securities
Large capitalization value	312		—		—		312
Smaller company growth	56		—		—		56
Total available-for-sale securities	377		911		—		1,288
REIT	—		—		79		79
Total Assets	$	377	$	911	$	79	$	1,367
Liabilities
Derivative financial instruments, net	$	—	$	72	$	—	$	72
Total Liabilities	$	—	$	72	$	—	$	72

The fair value of our REIT investment is measured based on NAV, which is considered a Level 3 input. A roll-forward for the three months ended March 31, 2017 of our REIT investment is as follows.



(Millions of dollars)	REIT
Balance at December 31, 2016	$	79
Purchases of securities	7
Sale of securities	—
Gains (losses) included in Accumulated other comprehensive income (loss)	2
Balance at March 31, 2017	$	88

In addition to the amounts above, Cat Financial impaired loans are subject to measurement at fair value on a nonrecurring basis and are classified as Level 3 measurements. A loan is considered impaired when management determines that collection of contractual amounts due is not probable. In these cases, an allowance for credit losses may be established based either on the present value of expected future cash flows discounted at the receivables' effective interest rate, or the fair value of the collateral for collateral-dependent receivables. In determining collateral value, Cat Financial estimates the current fair market value of the collateral less selling costs. Cat Financial had impaired loans with a fair value of $127 million and $137 million as of March 31, 2017 and December 31, 2016, respectively.

B. Fair values of financial instruments

In addition to the methods and assumptions we use to record the fair value of financial instruments as discussed in the Fair value measurements section above, we used the following methods and assumptions to estimate the fair value of our financial instruments:

Cash and short-term investments

Carrying amount approximated fair value.

Restricted cash and short-term investments

Carrying amount approximated fair value. Restricted cash and short-term investments are included in Prepaid expenses and other current assets in the Consolidated Statement of Financial Position.

Finance receivables

Fair value was estimated by discounting the future cash flows using current rates, representative of receivables with similar remaining maturities.

Wholesale inventory receivables

Fair value was estimated by discounting the future cash flows using current rates, representative of receivables with similar remaining maturities.

Short-term borrowings

Carrying amount approximated fair value.

Long-term debt

Fair value for fixed and floating rate debt was estimated based on quoted market prices.

Guarantees

The fair value of guarantees is based upon our estimate of the premium a market participant would require to issue the same guarantee in a stand-alone arms-length transaction with an unrelated party. If quoted or observable market prices are not available, fair value is based upon internally developed models that utilize current market-based assumptions.

Please refer to the table below for the fair values of our financial instruments.



	Fair Value of Financial Instruments
	March 31, 2017				December 31, 2016
(Millions of dollars)	Carrying Amount		Fair Value		Carrying Amount		Fair Value		Fair Value Levels	Reference
Assets
Cash and short-term investments	$	9,472	$	9,472	$	7,168	$	7,168	1
Restricted cash and short-term investments	63		63		31		31		1
Investments in debt and equity securities	1,362		1,362		1,367		1,367		1, 2 & 3	Note 8
Finance receivables – net (excluding finance leases ¹)	16,002		15,983		16,172		16,056		3	Note 16
Wholesale inventory receivables – net (excluding finance leases ¹)	1,424		1,391		1,500		1,464		3	Note 16
Interest rate contracts – net	2		2		3		3		2	Note 4
Commodity contracts – net	7		7		10		10		2	Note 4

Liabilities
Short-term borrowings	7,821		7,821		7,303		7,303		1
Long-term debt (including amounts due within one year)
Machinery, Energy & Transportation	9,309		10,771		8,943		10,348		2
Financial Products	21,152		21,341		20,537		20,724		2
Foreign currency contracts – net	30		30		85		85		2	Note 4
Guarantees	8		8		8		8		3	Note 10


¹	Total excluded items have a net carrying value at March 31, 2017 and December 31, 2016 of $6,301 million and $6,111 million, respectively.