Financial Instruments

The fair value of the Company’s financial instruments is generally determined by reference to market values resulting from trading on a national securities exchange or in an over-the-counter market. In some cases where quoted market prices are not available, prices are derived by considering the yield of the benchmark security that was issued to initially price the instruments and adjusting this rate by the credit spread that market participants would demand for the instruments as of the measurement date. The carrying amounts of cash and cash equivalents; receivables, net; program cash and accounts payable and other current liabilities approximate fair value due to the short-term maturities of these assets and liabilities.

Debt Instruments

The carrying amounts and estimated fair values of debt instruments were as follows:



		As of September 30, 2013				As of December 31, 2012
		Carrying Amount		Estimated Fair Value ^(a)		Carrying Amount		Estimated Fair Value^(a)
Corporate debt
	Short-term debt and current portion of long-term debt	$	181	$	181	$	57	$	58
	Long-term debt, excluding convertible debt	3,128		3,192		2,720		2,903
	Convertible debt	75		135		128		171

Debt under vehicle programs
	Vehicle-backed debt due to Avis Budget Rental Car Funding (AESOP) LLC	$	6,128	$	6,231	$	5,203	$	5,391
	Vehicle-backed debt	2,502		2,510		1,599		1,613
	Interest rate swaps and interest rate contracts ^(b)	6		6		4		4

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^(a)	The fair value measurements are based on significant observable inputs (Level 2).


^(b)	Derivatives in a liability position.

Net Investment Hedge

The Company has designated its 6% Euro-denominated notes issued March 2013 as a hedge of its net investment in Euro-denominated foreign operations. The Company records the effective portion of the gain or loss on this net investment hedge, net of taxes, in accumulated other comprehensive income as part of currency translation adjustments. For the three months and nine months ended September 30, 2013, the Company has recorded an $8 million loss, net of tax, in accumulated other comprehensive income. Any ineffective portion of the net investment hedge is immediately reclassified from accumulated other comprehensive income into earnings. There was no ineffectiveness during the three and nine months ended September 30, 2013 and the Company does not expect to reclassify any amounts from accumulated other comprehensive income into earnings over the next 12 months.

Derivative Instruments and Hedging Activities

The Company uses foreign exchange contracts to manage its exposure to changes in currency exchange rates associated with its foreign currency denominated receivables and forecasted royalties, forecasted earnings of foreign subsidiaries and forecasted foreign currency denominated acquisitions. The Company primarily hedges its foreign currency exposure to the Australian, Canadian and New Zealand dollars, the Euro and the British pound sterling. These forward contracts do not qualify for hedge accounting treatment; however, the fluctuations in the value of these forward contracts largely offset the impact of changes in the value of the underlying risk they economically hedge.

The Company uses various hedging strategies including interest rate swaps and interest rate caps to create an appropriate mix of fixed and floating rate assets and liabilities. The Company uses interest rate swaps to manage the risk related to its floating rate corporate debt and its floating rate vehicle-backed debt. The Company records the effective portion of changes in the fair value of its cash flow hedges to other comprehensive income, net of tax, and subsequently reclassifies these amounts into earnings in the period during which the hedged transaction is recognized. The Company records the gains or losses related to freestanding derivatives, which are not designated as a hedge for accounting purposes, in its consolidated results of operations. The changes in fair values of hedges that are determined to be ineffective are immediately reclassified from accumulated other comprehensive income into earnings. The Company estimates that the amount of gains or losses currently recorded in accumulated other comprehensive income which will be recognized in earnings over the next 12 months is not material.

From time to time, the Company enters into derivative commodity contracts to manage its exposure to changes in the price of unleaded gasoline. Changes in the fair value of these derivatives are recorded within operating expenses.

Certain of the Company’s derivative instruments contain collateral support provisions that require the Company to post cash collateral to the extent that such derivatives are in a liability position. The aggregate fair value of such derivatives and the aggregate fair value of assets needed to settle these derivatives as of September 30, 2013 was approximately $3 million, for which the Company has posted cash collateral in the normal course of business.

As of September 30, 2013, the Company held derivative instruments with absolute notional values as follows:



	As of
	September 30, 2013
Interest rate caps ^(a)	$	6,959
Interest rate swaps	904
Foreign exchange forward contracts	77
Foreign exchange swaps	704

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^(a)	Represents $4.7 billion of interest rate caps sold and approximately $2.2 billion of interest rate caps purchased. These amounts exclude $2.5 billion of interest rate caps purchased by the Company’s Avis Budget Rental Car Funding (AESOP) LLC (“Avis Budget Rental Car Funding”) subsidiary.

As of September 30, 2013, the Company also had commodity contracts for the purchase of 11 million gallons of unleaded gasoline.

The Company used significant observable inputs (Level 2 inputs) to determine the fair value of its derivative assets and liabilities. Derivatives entered into by the Company are typically executed over-the-counter and are valued using various valuation techniques, as no quoted market prices exist for such instruments. The valuation technique and inputs depend on the type of derivative and the nature of the underlying exposure. The principal techniques used to value these instruments are discounted cash flows and Black-Scholes option valuation models. These models take into account a variety of factors including, where applicable, maturity, commodity prices, interest rate yield curves of the Company and counterparties, credit curves, counterparty creditworthiness and currency exchange rates. These factors are applied on a consistent basis and are based upon observable inputs.

Fair values of derivative instruments were as follows:



		As of September 30, 2013				As of December 31, 2012
		Fair Value, Asset Derivatives		Fair Value, Liability Derivatives		Fair Value, Asset Derivatives		Fair Value, Liability Derivatives
Derivatives designated as hedging instruments
	Interest rate swaps ^(a)	$	—	$	1	$	—	$	1

Derivatives not designated as hedging instruments
	Currency exchange contracts ^(b)	4		4		3		8
	Interest rate contracts ^(c)	3		6		—		4
	Interest rate swaps ^(a)	—		—		—		12
	Commodity contracts ^(b)	—		2		—		—
	Total	$	7	$	13	$	3	$	25

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Amounts in this table exclude derivatives issued by Avis Budget Rental Car Funding, as it is not consolidated by the Company; however, certain amounts related to the derivatives held by Avis Budget Rental Car Funding are included within accumulated other comprehensive income, as discussed in Note 14—Stockholders’ Equity.


^(a)	Included in other non-current liabilities.


^(b)	Included in other current assets or other current liabilities.


^(c)	Included in assets under vehicle programs and liabilities under vehicle programs.

The effects of derivatives recognized in the Company’s Consolidated Condensed Financial Statements were as follows:



		Three Months Ended September 30,						Nine Months Ended September 30,
		2013			2012			2013		2012
Derivatives designated as hedging instruments
	Interest rate swaps ^(a)	$	—		$	—		$	1	$	11

Derivatives not designated as hedging instruments ^(b)
	Currency exchange contracts ^(c)	(13		)	(2		)	22		—
	Commodity contracts ^(d)	—			3			—		4
	Interest rate contracts ^(e)	(2		)	(5		)	5		(13		)
	Total	$	(15	)	$	(4	)	$	28	$	2

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^(a)	Recognized, net of tax, as a component of other comprehensive income within stockholders’ equity.


^(b)	Gains (losses) related to derivative instruments are expected to be largely offset by (losses) gains on the underlying exposures being hedged.


^(c)	For the three months ended September 30, 2013, included a $16 million loss in interest expense and a $3 million gain in operating expenses. For the nine months ended September 30, 2013, included a $13 million gain in interest expense and a $9 million gain in operating expenses. For the three and nine months ended September 30, 2012, amounts were included in operating expenses.


^(d)	Included in operating expense.


^(e)	Included in interest expense.