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 June 30 were as follows (in millions):



	Second Quarter						First Half
	2017			2018			2017			2018
Fair value hedges
Interest rate contracts
Net interest settlements and accruals on hedging instruments	$	62		$	(2	)	$	132		$	24
Fair value changes on hedging instruments (a)	34			(90		)	(55		)	(429		)
Fair value changes on hedged debt (a)	(30		)	82			55			411
Derivatives not designated as hedging instruments
Interest rate contracts	30			(20		)	37			(37		)
Foreign currency exchange contracts (b)	(61		)	110			(90		)	98
Cross-currency interest rate swap contracts	16			(125		)	74			(183		)
Total	$	51		$	(45	)	$	153		$	(116	)

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(a)	For the first half 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						June 30, 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	$	26,033	$	137	$	441
Derivatives not designated as hedging instruments
Interest rate contracts	60,504		276		137		65,447		247		255
Foreign currency exchange contracts	2,406		3		10		3,798		55		17
Cross-currency interest rate swap contracts	4,006		408		28		5,852		270		143
Total derivative financial instruments, gross (a) (b)	$	94,924	$	935	$	310	$	101,130	$	709	$	856

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(a)	At December 31, 2017 and June 30, 2018, we held collateral of $15 million and $9 million, respectively, and we posted collateral of $38 million and $56 million, respectively.


(b)	At December 31, 2017 and June 30, 2018, the fair value of assets and liabilities available for counterparty netting was $162 million and $212 million, respectively. All derivatives are categorized within Level 2 of the fair value hierarchy.