DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES

In the normal course of business, our operations are exposed to global market risks, including the effect of changes in foreign currency exchange rates, certain commodity prices, and interest rates. To manage these risks, we enter into various derivatives contracts:


•	Foreign currency exchange contracts, including forwards and options, that are used to manage foreign exchange exposure;


•	Commodity contracts, including forwards and options, that are used to manage commodity price risk;


•	Interest rate contracts including swaps, caps, and floors that are used to manage the effects of interest rate fluctuations; and


•	Cross-currency interest rate swap contracts that are used to manage foreign currency and interest rate exposures on foreign-denominated debt.

Our derivatives are over-the-counter customized derivative transactions and are not exchange-traded. We review our hedging program, derivative positions, and overall risk management strategy on a regular basis.

Overall Derivative Financial Instruments and Hedge Accounting. All derivatives are recognized on the balance sheet at fair value. To ensure consistency in our treatment of derivative and non-derivative exposures with regard to our master agreements, we do not net our derivative position by counterparty for purposes of balance sheet presentation and disclosure. We do, however, consider our net position for determining fair value.

We have elected to apply hedge accounting to certain derivatives. Derivatives that are designated are documented and the relationships are evaluated for effectiveness using regression analysis at the time they are designated and throughout the hedge period. Cash flows and profit impact associated with designated hedges are reported in the same category as the underlying hedged item.

Some derivatives do not qualify for hedge accounting; for others, we elect not to apply hedge accounting. Regardless of hedge accounting treatment, we only enter into transactions that we believe will be highly effective at offsetting the underlying economic risk. We report changes in the fair value of derivatives not designated as hedging instruments through Automotive cost of sales, Automotive interest income and other non-operating income/(expense), net, or Financial Services other income/(loss), net depending on the sector and underlying exposure. Cash flows associated with non-designated or de-designated derivatives are reported in Net cash (used in)/provided by investing activities in our statements of cash flows.

Cash Flow Hedges. Our Automotive sector has designated certain forward contracts as cash flow hedges of forecasted transactions with exposure to foreign currency exchange risk.

The effective portion of changes in the fair value of cash flow hedges is deferred in Accumulated other comprehensive income/(loss) and is recognized in Automotive cost of sales when the hedged item affects earnings. The ineffective portion is reported currently in Automotive cost of sales. Our policy is to de-designate cash flow hedges prior to the time forecasted transactions are recognized as assets or liabilities on the balance sheet and report subsequent changes in fair value through Automotive cost of sales. If it becomes probable that the originally-forecasted transaction will not occur, the related amount also is reclassified from Accumulated other comprehensive income/(loss) and recognized in earnings. Our cash flow hedges mature in two years or less.

Fair Value Hedges. Our Financial Services sector uses derivatives to reduce the risk of changes in the fair value of liabilities. We have designated certain receive-fixed, pay-float interest rate swaps as fair value hedges of fixed-rate debt. The risk being hedged is the risk of changes in the fair value of the hedged debt attributable to changes in the benchmark interest rate. If the hedge relationship is deemed to be highly effective, we record the changes in the fair value of the hedged debt related to the risk being hedged in Financial Services debt with the offset in Financial Services other income/(loss), net. The change in fair value of the related derivative (excluding accrued interest) also is recorded in Financial Services other income/(loss), net. Hedge ineffectiveness, recorded directly in earnings, is the difference between the change in fair value of the derivative and the change in the fair value of the hedged debt that is attributable to the changes in the benchmark interest rate.

When a derivative is de-designated from a fair value hedge relationship, or when the derivative in a fair value hedge relationship is terminated before maturity, the fair value adjustment to the hedged debt continues to be reported as part of the carrying value of the debt and is amortized over its remaining life.

NOTE 16. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES (Continued)

Net Investment Hedges. We have used foreign currency exchange derivatives to hedge the net assets of certain foreign entities to offset the translation and economic exposures related to our investment in these entities. The effective portion of changes in the value of these derivative instruments is included in Accumulated other comprehensive income/(loss) as a foreign currency translation adjustment until the hedged investment is sold or liquidated. When the investment is sold or liquidated, the hedge gains and losses previously reported in Accumulated other comprehensive income/(loss) are recognized in Automotive interest income and other non-operating income/(expense), net as part of the gain or loss on sale. We have had no derivative instruments in an active net investment hedging relationship since the first quarter of 2007.

Normal Purchases and Normal Sales Classification. We have elected to apply the normal purchases and normal sales classification for physical supply contracts that are entered into for the purpose of procuring commodities to be used in production over a reasonable period in the normal course of our business.

Income Effect of Derivative Instruments

The following tables summarize by hedge designation the pre-tax gains/(losses) recorded in Other comprehensive income/(loss) ("OCI"), reclassified from Accumulated other comprehensive income/(loss) ("AOCI" ) to income and/or recognized directly in income (in millions):



	Second Quarter 2011							First Half 2011
	Gain/(Loss) Recorded in OCI		Gain/(Loss) Reclassified from AOCI to Income		Gain/(Loss) Recognized in Income			Gain/(Loss) Recorded in OCI		Gain/(Loss) Reclassified from AOCI to Income		Gain/(Loss) Recognized in Income
Automotive Sector
Cash flow hedges:
Foreign currency exchange contracts	$	69	$	42	$	2		$	194	$	36	$	2
Derivatives not designated as hedging instruments:
Foreign currency exchange contracts - operating exposures					$	4						$	13
Commodity contracts					(27		)					(12		)
Other – warrants					1							1
Total					$	(22	)					$	2

Financial Services Sector
Fair value hedges:
Interest rate contracts
Net interest settlements and accruals excluded from the assessment of hedge effectiveness					$	67						$	133
Ineffectiveness (a)					2							(16		)
Total					$	69						$	117
Derivatives not designated as hedging instruments:
Interest rate contracts					$	4						$	(4	)
Foreign currency exchange contracts					(74		)					(62		)
Cross-currency interest rate swap contracts					(17		)					(31		)
Other (b)					2							2
Total					$	(85	)					$	(95	)

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(a) For the second quarter and first half of 2011, hedge ineffectiveness reflects change in fair value on derivatives of $134 million gain and $46 million gain, respectively, and change in fair value on hedged debt of $132 million loss and $62 million loss, respectively.

(b) Reflects gains/(losses) for derivative features included in the FUEL notes (see Note 3).

NOTE 16. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES (Continued)



	Second Quarter 2010									First Half 2010
	Gain/(Loss) Recorded in OCI			Gain/(Loss) Reclassified from AOCI to Income			Gain/(Loss) Recognized in Income			Gain/(Loss) Recorded in OCI			Gain/(Loss) Reclassified from AOCI to Income			Gain/(Loss) Recognized in Income
Automotive Sector
Cash flow hedges:
Foreign currency exchange contracts	$	(46	)	$	(10	)	$	—		$	(51	)	$	(13	)	$	—
Derivatives not designated as hedging instruments:
Foreign currency exchange contracts - operating exposures							$	(45	)							$	(200	)
Commodity contracts							(12		)							(15		)
Other – warrants							—									1
Total							$	(57	)							$	(214	)

Financial Services Sector
Fair value hedges:
Interest rate contracts
Net interest settlements and accruals excluded from the assessment of hedge effectiveness							$	52								$	105
Ineffectiveness *							2									—
Total							$	54								$	105
Derivatives not designated as hedging instruments:
Interest rate contracts							$	2								$	31
Foreign currency exchange contracts							(10		)							(90		)
Cross-currency interest rate swap contracts							96									88
Total							$	88								$	29

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* For the second quarter and first half of 2010, hedge ineffectiveness reflects change in fair value on derivatives of $112 million gain and $155 million gain, respectively, and change in fair value on hedged debt of $110 million loss and $155 million loss, respectively.

For our Financial Services sector, net interest settlements and accruals on fair value hedges are excluded from the assessment of hedge effectiveness. We report net interest settlements and accruals on fair value hedges in Interest expense on our consolidated statement of operations, with the exception of foreign currency revaluation on accrued interest, which is reported in Selling, administrative, and other expenses. Ineffectiveness on fair value hedges and gains and losses on interest rate contracts not designated as hedging instruments are reported in Financial Services other income/(loss), net. Gains and losses on foreign exchange and cross-currency interest rate swap contracts not designated as hedging instruments are reported in Selling, administrative, and other expenses.

NOTE 16. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES (Continued)

Balance Sheet Effect of Derivative Instruments

The following tables summarize the notional amount and estimated fair value of our derivative financial instruments (in millions):



	June 30, 2011
	Notionals		Fair Value of Assets		Fair Value of Liabilities
Automotive Sector
Cash flow hedges:
Foreign currency exchange contracts	$	6,260	$	215	$	72

Derivatives not designated as hedging instruments:
Foreign currency exchange contracts	2,631		92		78
Commodity contracts	2,224		24		46
Other – warrants	12		6		—
Total derivatives not designated as hedging instruments	4,867		122		124

Total Automotive sector derivative instruments	$	11,127	$	337	$	196

Financial Services Sector
Fair value hedges:
Interest rate contracts	$	7,850	$	260	$	—

Derivatives not designated as hedging instruments:
Interest rate contracts	63,604		660		205
Foreign currency exchange contracts	7,637		64		66
Cross-currency interest rate swap contracts	1,114		—		42
Other *	2,500		75		—
Total derivatives not designated as hedging instruments	74,855		799		313

Total Financial Services sector derivative instruments	$	82,705	$	1,059	$	313

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* Represents derivative features included in the FUEL notes (see Note 3).

NOTE 16. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES (Continued)



	December 31, 2010
	Notionals		Fair Value of Assets		Fair Value of Liabilities
Automotive Sector
Cash flow hedges:
Foreign currency exchange contracts	$	664	$	8	$	15

Derivatives not designated as hedging instruments:
Foreign currency exchange contracts	2,167		50		78
Commodity contracts	846		69		6
Other – warrants	12		5		—
Total derivatives not designated as hedging instruments	3,025		124		84

Total Automotive sector derivative instruments	$	3,689	$	132	$	99

Financial Services Sector
Fair value hedges:
Interest rate contracts	$	8,826	$	503	$	7

Derivatives not designated as hedging instruments:
Interest rate contracts	52,999		709		322
Foreign currency exchange contracts	3,835		24		73
Cross-currency interest rate swap contracts	1,472		25		189
Total derivatives not designated as hedging instruments	58,306		758		584

Total Financial Services sector derivative instruments	$	67,132	$	1,261	$	591

On our consolidated balance sheet, Automotive and Financial Services sectors report derivative assets in Other assets. Derivative liabilities are reported in Payables for our Automotive sector and in Accrued liabilities and deferred revenue for our Financial Services sector.

The notional amounts of the derivative financial instruments do not represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the financial risks described above. The amounts exchanged are calculated by reference to the notional amounts and by other terms of the derivatives, such as interest rates, foreign currency exchange rates or commodity volumes and prices.

Counterparty Risk and Collateral

Use of derivatives exposes us to the risk that a counterparty may default on a derivative contract. We establish exposure limits for each counterparty to minimize this risk and provide counterparty diversification. Substantially all of our derivative exposures are with counterparties that have long-term credit ratings of single-A or better. The aggregate fair value of derivative instruments in asset positions on June 30, 2011 was $1.4 billion, representing the maximum loss that we would recognize at that date if all counterparties failed to perform as contracted. We enter into master agreements with counterparties that generally allow for netting of certain exposures; therefore, the actual loss we would recognize if all counterparties failed to perform as contracted would be significantly lower.

We include an adjustment for non-performance risk in the fair value of derivative instruments. Our adjustment for non-performance risk is relative to a measure based on an unadjusted inter-bank deposit rate (e.g., LIBOR). For our Automotive sector, at June 30, 2011 and December 31, 2010, our net adjustment reduced derivative assets and derivative liabilities by less than $1 million, respectively. For our Financial Services sector, at June 30, 2011 and

December 31, 2010, our adjustment increased derivative assets by $3 million and reduced derivative assets by $10 million, respectively, and reduced derivative liabilities by $3 million and $4 million, respectively. See Note 3 for more detail on valuation methodologies.

We post cash collateral with certain counterparties based on our net position with regard to foreign currency and commodity derivative contracts. We posted $0 and $11 million as of June 30, 2011 and December 31, 2010, respectively, which is reported in Other assets on our consolidated balance sheet.