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 interest rates and foreign currency exchange rates. To manage these risks, we enter into highly effective derivative contracts. We have elected to apply hedge accounting to certain derivatives. Derivatives that are designated in hedging relationships are evaluated for effectiveness using regression analysis at the time they are designated and throughout the hedge period. Some derivatives do not qualify for hedge accounting; for others, we elect not to apply hedge accounting.

Income Effect of Derivative Financial Instruments

The gains / (losses), by hedge designation, recorded in income for the periods ended March 31 were as follows (in millions):



	First Quarter
	2017			2018
Fair value hedges
Interest rate contracts
Net interest settlements and accruals on hedging instruments	$	70		$	26
Fair value changes on hedging instruments (a)	(89		)	(339		)
Fair value changes on hedged debt (a)	85			329
Derivatives not designated as hedging instruments
Interest rate contracts	7			(17		)
Foreign currency exchange contracts (b)	(29		)	(12		)
Cross-currency interest rate swap contracts	58			(58		)
Total	$	102		$	(71	)

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(a)	For the first quarter of 2017, the fair value changes on hedging instruments and on hedged debt were reported in Other income, net; effective first quarter 2018, these amounts were reported in Interest expense.


(b)	Reflects forward contracts between Ford Credit and an affiliated company.

NOTE 9. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES (Continued)

Balance Sheet Effect of Derivative Financial Instruments

Derivative assets and liabilities are recorded on the balance sheet at fair value and are presented on a gross basis. The notional amounts of the derivative instruments do not necessarily represent amounts exchanged by the parties and are not a direct measure of our financial exposure. We also enter into master agreements with counterparties that may allow for netting of exposure in the event of default or breach of the counterparty agreement. Collateral represents cash received or paid under reciprocal arrangements that we have entered into with our derivative counterparties which we do not use to offset our derivative assets and liabilities.

The fair value of our derivative instruments and the associated notional amounts, presented gross, were as follows (in millions):



	December 31, 2017						March 31, 2018
	Notional		Fair Value of Assets		Fair Value of Liabilities		Notional		Fair Value of Assets		Fair Value of Liabilities
Fair value hedges
Interest rate contracts	$	28,008	$	248	$	135	$	30,250	$	139	$	516
Derivatives not designated as hedging instruments
Interest rate contracts	60,504		276		137		60,453		282		184
Foreign currency exchange contracts	2,406		3		10		2,885		28		34
Cross-currency interest rate swap contracts	4,006		408		28		5,712		305		60
Total derivative financial instruments, gross (a) (b)	$	94,924	$	935	$	310	$	99,300	$	754	$	794

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(a)	At December 31, 2017 and March 31, 2018, we held collateral of $15 million and $22 million, respectively, and we posted collateral of $38 million and $55 million, respectively.


(b)	At December 31, 2017 and March 31, 2018, the fair value of assets and liabilities available for counterparty netting was $162 million and $231 million, respectively. All derivatives are categorized within Level 2 of the fair value hierarchy.

Fair Value Hedges

The carrying value of and fair value adjustments to our hedged debt were as follows (in millions):



	December 31, 2017					March 31, 2018
	Carrying Value		Fair Value Adjustments (a)			Carrying Value		Fair Value Adjustments (a)
Debt	$	38,976	$	(21	)	$	39,733	$	(360	)

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(a)	At December 31, 2017 and March 31, 2018, the balance includes unfavorable adjustments of $77 million and $66 million, respectively, related to discontinued hedging relationships.