Derivative Instruments

The Company enters into derivative transactions in certain situations based on management’s assessment of current market conditions and perceived risks. Management intends to respond to evolving business and market conditions and in doing so, may enter into such transactions as deemed appropriate.

Credit Risk. As a result of the use of derivative instruments, the Company is exposed to counterparty credit risk. The Company manages this risk by limiting its counterparties to large financial institutions which meet the Company’s credit rating standards and have an established banking relationship with the Company. As of September 30, 2017, the Company did not expect any losses as a result of default of its counterparties.

Interest Rate Derivative Instruments. In May 2017, the Company executed four treasury lock agreements with an aggregate notional value of $275.0 million and a weighted average interest rate of 2.85%. The purpose of the treasury locks is to hedge the U.S. Treasury benchmark interest rate associated with future interest payments related to the anticipated refinancing of the $275.0 million of KCS 2.35% senior notes due May 15, 2020. The Company has designated the treasury locks as cash flow hedges and recorded unrealized gains and losses in Accumulated other comprehensive income. Upon settlement, the unrealized gain or loss in Accumulated other comprehensive income will be amortized to interest expense over the life of the future underlying debt issuance.

Foreign Currency Derivative Instruments. The Company’s Mexican subsidiaries have net U.S. dollar-denominated monetary liabilities which, for Mexican income tax purposes, are subject to periodic revaluation based on changes in the value of the Mexican peso against the U.S. dollar. This revaluation creates fluctuations in the Company’s Mexican income tax expense and the amount of income taxes paid in Mexico. The Company hedges its exposure to this cash tax risk by entering into foreign currency forward contracts and foreign currency option contracts known as zero-cost collars.

The foreign currency forward contracts involve the Company’s purchase of pesos at an agreed-upon weighted-average exchange rate to each U.S dollar. The zero-cost collars involve the Company’s purchase of a Mexican peso call option and a simultaneous sale of a Mexican peso put option, with equivalent U.S. dollar notional amounts for each option and no net cash premium paid by the Company. The Company does not physically exchange currencies upon maturity or expiration of its forward contracts or zero-cost collars. Instead, the Company settles the maturing/expiring transactions by entering into offsetting transactions, which results in a physical exchange of only the net gain or loss between the Company and the counterparty.

Below is a summary of the Company’s 2017 and 2016 foreign currency derivative contracts (amounts in millions, except Ps./USD):



Foreign currency forward contracts
	Contracts to purchase Ps./pay USD								Offsetting contracts to sell Ps./receive USD
	Notional amount		Notional amount		Weighted-average exchange rate (in Ps./USD)		Maturity date		Notional amount			Notional amount		Weighted-average exchange rate (in Ps./USD)		Maturity date	Cash received/(paid) on settlement
Contracts executed in 2016 and settled in 2017	$	340.0	Ps.	6,207.7	Ps.	18.3	1/17/2017		$	287.0		Ps.	6,207.7	Ps.	21.6	1/17/2017	$	(53.0	)
Contracts executed in 2016 and settled in 2016	$	60.0	Ps.	1,057.3	Ps.	17.6	4/29/2016		$	60.7		Ps.	1,057.3	Ps.	17.4	4/29/2016	$	0.7
Contracts executed in 2015 and settled in 2016	$	300.0	Ps.	4,480.4	Ps.	14.9	1/15/2016		$	251.0		Ps.	4,480.4	Ps.	17.9	1/15/2016	$	(49.0	)

Foreign currency zero-cost collar contracts
	Notional amount		Maturity date		Weighted-average call rate outstanding options (in Ps./USD)		Weighted-average put rate outstanding options (in Ps./USD)		Cash received/(paid) on settlement
Contracts executed in 2017 and partially settled in 2017	$	255.0	1/16/2018		Ps.	21.6	Ps.	24.7	$	7.7	(i)
Contracts executed in 2017 and settled in 2017	$	10.0	1/18/2018		—		—		$	0.4
Contracts executed in 2017 and settled in 2017	$	70.0	7/27/2017		—		—		$	4.7
Contracts executed in 2017 and settled in 2017	$	195.0	4/25/2017		—		—		$	25.8
Contracts executed in 2015 and settled in 2016	$	80.0	1/15/2016		—		—		$	(10.1	)

(i) During February and September 2017, the Company settled $115.0 million and $25.0 million, respectively, of the zero-cost collar contracts.

The Company has not designated any of the foreign currency derivative contracts as hedging instruments for accounting purposes. The Company measures the foreign currency derivative contracts at fair value each period and recognizes any change in fair value in Foreign exchange gain (loss) within the Consolidated Statements of Income.

The following tables present the fair value of derivative instruments included in the Consolidated Balance Sheets (in millions):



	Derivative Assets
	Balance Sheet Location	September 30, 2017		December 31, 2016
Derivatives not designated as hedging instruments:
Foreign currency zero-cost collar contracts	Other current assets	$	18.8	$	—
Total derivatives not designated as hedging instruments		18.8		—
Total derivative assets		$	18.8	$	—



	Derivative Liabilities
	Balance Sheet Location	September 30, 2017		December 31, 2016
Derivatives designated as hedging instruments:
Treasury lock agreements	Other noncurrent liabilities and deferred credits	$	4.6	$	—
Total derivatives designated as hedging instruments		4.6		—
Derivatives not designated as hedging instruments:
Foreign currency forward contracts	Accounts payable and accrued liabilities	—		41.1
Total derivatives not designated as hedging instruments		—		41.1
Total derivative liabilities		$	4.6	$	41.1

The following table presents the effects of derivative instruments on the Consolidated Statements of Income and Consolidated Statements of Comprehensive Income (in millions):



Derivatives in Cash Flow Hedging Relationships		Amount of Gain/(Loss) Recognized in OCI on Derivative
		Three Months Ended						Nine Months Ended
		September 30,						September 30,
		2017			2016			2017			2016
Treasury lock agreements		$	(0.8	)	$	—		$	(4.6	)	$	—
Total		$	(0.8	)	$	—		$	(4.6	)	$	—

Derivatives Not Designated as Hedging Instruments	Location of Gain/(Loss) Recognized in Income on Derivative	Amount of Gain/(Loss) Recognized in Income on Derivative
		Three Months Ended						Nine Months Ended
		September 30,						September 30,
		2017			2016			2017			2016
Foreign currency forward contracts	Foreign exchange gain (loss)	$	—		$	(16.1	)	$	(11.9	)	$	(31.9	)
Foreign currency zero-cost collar contracts	Foreign exchange gain (loss)	3.3			—			57.4			(3.9		)
Total		$	3.3		$	(16.1	)	$	45.5		$	(35.8	)