A significant portion of the Company’s revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives and accounting related to the Company’s foreign currency risk management program, as well as its interest rate risk management activities are discussed below.

The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro, Japanese yen and Chinese renminbi. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts and purchased collar options.

The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Condensed Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or Other comprehensive income (OCI), depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the unrealized gains or losses on these contracts are recorded in Accumulated other comprehensive income (AOCI) and reclassified into Sales when the hedged anticipated revenue is recognized. For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Condensed Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes.

The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiary’s functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Condensed Consolidated Statement of Cash Flows.

Monetary assets and liabilities denominated in a currency other than the functional currency of a given subsidiary are remeasured at spot rates in effect on the balance sheet date with the effects of changes in spot rates reported in Other (income) expense, net. The forward contracts are not designated as hedges and are marked to market through Other (income) expense, net. Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the remeasured

The Company also uses forward exchange contracts to hedge a portion of its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The unrealized gains or losses on these contracts are recorded in foreign currency translation adjustment within OCI and remain in AOCI until either the sale or complete or substantially complete liquidation of the subsidiary. The Company excludes certain portions of the change in fair value of its derivative instruments from the assessment of hedge effectiveness (excluded components). Changes in fair value of the excluded components are recognized in OCI. The Company recognizes in earnings the initial value of the excluded components on a straight-line basis over the life of the derivative instrument, rather than using the mark-to-market approach. The cash flows from these contracts are reported as investing activities in the Condensed Consolidated Statement of Cash Flows.

Foreign exchange risk is also managed through the use of foreign currency debt. The Company’s senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI.


	Amount of Pretax (Gain) Loss Recognized in Other Comprehensive Income (1)								Amount of Pretax (Gain) Loss Recognized in Other (income) expense, net for Amounts Excluded from Effectiveness Testing
	Three Months Ended September 30,				Nine Months Ended September 30,				Three Months Ended September 30,				Nine Months Ended September 30,
($ in millions)	2020		2019		2020		2019		2020		2019		2020		2019
Net Investment Hedging Relationships
Foreign exchange contracts	$	10	$	1	$	15	$	8	$	(4)	$	(8)	$	(15)	$	(23)
Euro-denominated notes	162		(150)		182		(152)		—		—		—		—

The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk.

In February 2020, five interest rate swaps with notional amounts of $250 million each matured. These swaps effectively converted the Company’s $1.25 billion, 1.85% fixed-rate notes due 2020 to variable rate debt. At September 30, 2020, the Company was a party to 14 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below.

The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense along with the offsetting fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Condensed Consolidated Statement of Cash Flows.


	Carrying Amount of Hedged Liabilities				Cumulative Amount of Fair Value Hedging Adjustment Increase (Decrease) Included in the Carrying Amount
($ in millions)	September 30, 2020		December 31, 2019		September 30, 2020		December 31, 2019
Balance Sheet Line Item in which Hedged Item is Included
Loans payable and current portion of long-term debt	$	1,155	$	1,249	$	5	$	(1)
Long-Term Debt	2,309		3,409		62		14


		September 30, 2020						December 31, 2019
		Fair Value of Derivative				U.S. Dollar Notional		Fair Value of Derivative				U.S. Dollar Notional
($ in millions)	Balance Sheet Caption	Asset		Liability				Asset		Liability
Derivatives Designated as Hedging Instruments
Interest rate swap contracts	Other current assets	$	6	$	—	$	1,150	$	—	$	—	$	—
Interest rate swap contracts	Other Assets	63		—		2,250		15		—		3,400
Interest rate swap contracts	Accrued and other current liabilities	—		—		—		—		1		1,250
Foreign exchange contracts	Other current assets	30		—		4,120		152		—		6,117
Foreign exchange contracts	Other Assets	59		—		1,881		55		—		2,160
Foreign exchange contracts	Accrued and other current liabilities	—		104		3,096		—		22		1,748
Foreign exchange contracts	Other Noncurrent Liabilities	—		1		157		—		1		53
		$	158	$	105	$	12,654	$	222	$	24	$	14,728
Derivatives Not Designated as Hedging Instruments
Foreign exchange contracts	Other current assets	$	81	$	—	$	5,455	$	66	$	—	$	7,245
Foreign exchange contracts	Accrued and other current liabilities	—		171		8,042		—		73		8,693
Forward contract related to Seagen common stock	Accrued and other current liabilities	—		22		1,000		—		—		—
		$	81	$	193	$	14,497	$	66	$	73	$	15,938
		$	239	$	298	$	27,151	$	288	$	97	$	30,666

As noted above, the Company records its derivatives on a gross basis in the Condensed Consolidated Balance Sheet. The Company has master netting agreements with several of its financial institution counterparties (see Concentrations of Credit Risk below). The following table provides information on the Company’s derivative positions subject to these master netting arrangements as if they were presented on a net basis, allowing for the right of offset by counterparty and cash collateral exchanged per the master agreements and related credit support annexes:


	September 30, 2020				December 31, 2019
($ in millions)	Asset		Liability		Asset		Liability
Gross amounts recognized in the condensed consolidated balance sheet	$	239	$	298	$	288	$	97
Gross amounts subject to offset in master netting arrangements not offset in the condensed consolidated balance sheet	(140)		(140)		(84)		(84)
Cash collateral received	—		—		(34)		—
Net amounts	$	99	$	158	$	170	$	13


	Sales				Other (income) expense, net (1)				Other comprehensive income (loss)				Sales				Other (income) expense, net (1)				Other comprehensive income (loss)
	Three Months Ended September 30,				Three Months Ended September 30,				Three Months Ended September 30,				Nine Months Ended September 30,				Nine Months Ended September 30,				Nine Months Ended September 30,
($ in millions)	2020		2019		2020		2019		2020		2019		2020		2019		2020		2019		2020		2019
Financial Statement Line Items in which Effects of Fair Value or Cash Flow Hedges are Recorded	$	12,551	$	12,397	$	(312)	$	35	$	10	$	(28)	$	35,479	$	34,972	$	(630)	$	362	$	(190)	$	155
(Gain) loss on fair value hedging relationships
Interest rate swap contracts
Hedged items	—		—		(14)		13		—		—		—		—		54		101		—		—
Derivatives designated as hedging instruments	—		—		—		(6)		—		—		—		—		(76)		(74)		—		—
Impact of cash flow hedging relationships
Foreign exchange contracts
Amount of (loss) gain recognized in OCI on derivatives	—		—		—		—		(195)		186		—		—		—		—		(126)		183
Increase (decrease) in Sales as a result of AOCI reclassifications	(23)		70		—		—		23		(70)		65		189		—		—		(65)		(189)
Interest rate contracts
Amount of gain recognized in Other (income) expense, net on derivatives	—		—		(1)		(1)		—		—		—		—		(3)		(3)		—		—
Amount of loss recognized in OCI on derivatives	—		—		—		—		(1)		(1)		—		—		—		—		(3)		(6)


		Amount of Derivative Pretax (Gain) Loss Recognized in Income
		Three Months Ended September 30,				Nine Months Ended September 30,
($ in millions)	Income Statement Caption	2020		2019		2020		2019
Derivatives Not Designated as Hedging Instruments
Foreign exchange contracts (1)	Other (income) expense, net	$	(7)	$	(8)	$	(138)	$	112
Foreign exchange contracts (2)	Sales	7		(11)		4		(7)
Interest rate contracts (3)	Other (income) expense, net	—		—		9		—
Forward contract related to Seagen common stock	Research and development expenses	22		—		22		—

At September 30, 2020, the Company estimates $155 million of pretax net unrealized losses on derivatives maturing within the next 12 months that hedge foreign currency denominated sales over that same period will be reclassified from AOCI to Sales. The amount ultimately reclassified to Sales may differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity.


	September 30, 2020								December 31, 2019
	Amortized Cost		Gross Unrealized				Fair Value		Amortized Cost		Gross Unrealized				Fair Value
($ in millions)			Gains		Losses						Gains		Losses
U.S. government and agency securities	$	74	$	—	$	—	$	74	$	266	$	3	$	—	$	269
Foreign government bonds	2		—		—		2		—		—		—		—
Commercial paper	—		—		—		—		668		—		—		668
Corporate notes and bonds	—		—		—		—		608		13		—		621
Asset-backed securities	—		—		—		—		226		1		—		227
Total debt securities	$	76	$	—	$	—	$	76	$	1,768	$	17	$	—	$	1,785
Publicly traded equity securities (1)							1,477								838
Total debt and publicly traded equity securities							$	1,553							$	2,623

(1) Unrealized net (gains) losses recognized in Other (income) expense, net on equity securities still held at September 30, 2020 were $(43) million and $(512) million in the third quarter and first nine months of 2020, respectively. Unrealized net losses (gains) recognized in Other (income) expense, net on equity securities still held at September 30, 2019 were $25 million and $(41) million in the third quarter and first nine months of 2019, respectively.

At September 30, 2020 and September 30, 2019, the Company also had $508 million and $393 million, respectively, of equity investments without readily determinable fair values included in Other Assets. The Company recognizes unrealized gains on these equity investments based on favorable observable price changes from transactions involving similar investments of the same investee and recognizes unrealized losses based on unfavorable observable price changes. During the first nine months of 2020, the Company recognized unrealized gains of $21 million and unrealized losses of $3 million in Other (income) expense, net related to these equity investments held at September 30, 2020. During the first nine months of 2019, the Company recognized unrealized gains of $4 million and unrealized losses of $12 million in Other (income) expense, net related to these investments held at September 30, 2019. Cumulative unrealized gains and cumulative unrealized losses based on observable prices changes for investments in equity investments without readily determinable fair values still held at September 30, 2020 were $128 million and $24 million, respectively.

Fair value is defined 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 on the measurement date. The Company uses a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 - Quoted prices (unadjusted) in active markets for identical assets or liabilities; Level 2 - Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; Level 3 - Unobservable inputs that are supported by little or no market activity. Level 3 assets or liabilities are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as assets or liabilities for which the determination of fair value requires significant judgment or estimation. If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.


	Fair Value Measurements Using								Fair Value Measurements Using
	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
($ in millions)	September 30, 2020								December 31, 2019
Assets
Investments
Foreign government bonds	$	—	$	2	$	—	$	2	$	—	$	—	$	—	$	—
Commercial paper	—		—		—		—		—		668		—		668
Corporate notes and bonds	—		—		—		—		—		621		—		621
Asset-backed securities (1)	—		—		—		—		—		227		—		227
U.S. government and agency securities	—		—		—		—		—		209		—		209
Publicly traded equity securities	1,370		—		—		1,370		518		—		—		518
	1,370		2		—		1,372		518		1,725		—		2,243
Other assets (2)
U.S. government and agency securities	74		—		—		74		60		—		—		60
Publicly traded equity securities	107		—		—		107		320		—		—		320
	181		—		—		181		380		—		—		380
Derivative assets (3)
Forward exchange contracts	—		116		—		116		—		169		—		169
Interest rate swaps	—		69		—		69		—		15		—		15
Purchased currency options	—		54		—		54		—		104		—		104
	—		239		—		239		—		288		—		288
Total assets	$	1,551	$	241	$	—	$	1,792	$	898	$	2,013	$	—	$	2,911
Liabilities
Other liabilities
Contingent consideration	$	—	$	—	$	829	$	829	$	—	$	—	$	767	$	767
Derivative liabilities (3)
Forward exchange contracts	—		275		—		275		—		95		—		95
Forward contract related to Seagen common stock	—		22		—		22		—		—		—		—
Written currency options	—		1		—		1		—		1		—		1
Interest rate swaps	—		—		—		—		—		1		—		1
	—		298		—		298		—		97		—		97
Total liabilities	$	—	$	298	$	829	$	1,127	$	—	$	97	$	767	$	864

(3) At September 30, 2020 and December 31, 2019, $637 million and $625 million, respectively, of the liabilities relate to the termination of the Sanofi-Pasteur MSD joint venture in 2016. As part of the termination, Merck recorded a liability for contingent future royalty payments of 11.5% on net sales of all Merck products that were previously sold by the joint venture through December 31, 2024. The fair value of this liability is determined utilizing the estimated amount and timing of projected cash flows using a risk-adjusted discount rate of 8% to present value the cash flows.

The estimated fair value of loans payable and long-term debt (including current portion) at September 30, 2020, was $32.6 billion compared with a carrying value of $28.7 billion and at December 31, 2019, was $28.8 billion compared with a carrying value of $26.3 billion. Fair value was estimated using recent observable market prices and would be considered Level 2 in the fair value hierarchy.

On an ongoing basis, the Company monitors concentrations of credit risk associated with corporate and government issuers of securities and financial institutions with which it conducts business. Credit exposure limits are established to limit a concentration with any single issuer or institution. Cash and investments are placed in instruments that meet high credit quality standards as specified in the Company’s investment policy guidelines.

The majority of the Company’s accounts receivable arise from product sales in the United States, Europe and China and are primarily due from drug wholesalers and retailers, hospitals, government agencies, managed health care providers and pharmacy benefit managers. The Company monitors the financial performance and creditworthiness of its customers so that it can properly assess and respond to changes in their credit profile. The Company also continues to monitor global economic conditions, including the volatility associated with international sovereign economies, and associated impacts on the financial markets and its business.

The Company has accounts receivable factoring agreements with financial institutions in certain countries to sell accounts receivable. The Company factored $2.1 billion and $2.7 billion of accounts receivable in the third quarter of 2020 and the fourth quarter of 2019, respectively, under these factoring arrangements, which reduced outstanding accounts receivable. The cash received from the financial institutions is reported within operating activities in the Consolidated Statement of Cash Flows. In certain of these factoring arrangements, for ease of administration, the Company will collect customer payments related to the factored receivables, which it then remits to the financial institutions. The net cash flows relating to these collections are reported as financing activities in the Consolidated Statement of Cash Flows. The cost of factoring such accounts receivable was de minimis.

Derivative financial instruments are executed under International Swaps and Derivatives Association master agreements. The master agreements with several of the Company’s financial institution counterparties also include credit support annexes. These annexes contain provisions that require collateral to be exchanged depending on the value of the derivative assets and liabilities, the Company’s credit rating, and the credit rating of the counterparty. Cash collateral received by the Company from various counterparties was $34 million at December 31, 2019. The obligation to return such collateral is recorded in Accrued and other current liabilities. No cash collateral was advanced by the Company to counterparties as of September 30, 2020 or December 31, 2019.