Financial Instruments

A. Selected Financial Assets and Liabilities

The following table provides additional information about certain of our financial assets and liabilities:



(MILLIONS OF DOLLARS)	March 31, 2013		December 31, 2012
Selected financial assets measured at fair value on a recurring basis^(a)
Trading securities^(b)	$	119	$	142
Available-for-sale debt securities^(c)	43,811		32,584
Available-for-sale money market funds^(d)	1,117		1,727
Available-for-sale equity securities, excluding money market funds^(c)	312		263
Derivative financial instruments in receivable positions:^(e)
Interest rate swaps	791		1,036
Foreign currency swaps	288		194
Foreign currency forward-exchange contracts	249		152
	46,687		36,098
Other selected financial assets
Held-to-maturity debt securities, carried at amortized cost^{(c), (f)}	1,470		1,513
Private equity securities, carried at equity method or at cost^(f), ^(g)	2,434		1,239
	3,904		2,752
Total selected financial assets	$	50,591	$	38,850
Financial liabilities measured at fair value on a recurring basis^(a)
Derivative financial instruments in a liability position:^(h)
Foreign currency swaps	$	823	$	428
Foreign currency forward-exchange contracts	99		243
Interest rate swaps	26		33
	948		704
Other financial liabilities⁽ⁱ⁾
Short-term borrowings, carried at historical proceeds, as adjusted^(f)	8,896		6,424
Long-term debt, carried at historical proceeds, as adjusted^{(j), (k)}	31,481		31,036
	40,377		37,460
Total selected financial liabilities	$	41,325	$	38,164


^(a)	We use a market approach in valuing financial instruments on a recurring basis. For additional information, see Note 1C. Basis of Presentation and Significant Accounting Policies: Fair Value. All of our financial assets and liabilities measured at fair value on a recurring basis use Level 2 inputs in the calculation of fair value, except less than 1% that use Level 1 or Level 3 inputs.


^(b)	Trading securities are held in trust for legacy business acquisition severance benefits.


^(c)	Gross unrealized gains and losses are not significant.


^(d)	Includes $422 million as of March 31, 2013 and $408 million as of December 31, 2012 of money market funds held in trust in connection with the asbestos litigation involving Quigley Company, Inc., a wholly owned subsidiary.


^(e)	Designated as hedging instruments, except for certain contracts used as offsets; namely, foreign currency forward-exchange contracts with fair values of $155 million as of March 31, 2013; and foreign currency forward-exchange contracts with fair values of $102 million as of December 31, 2012.

^(f)

The differences between the estimated fair values and carrying values of held-to-maturity debt securities, private equity securities at cost and short-term borrowings not measured at fair value on a recurring basis were not significant as of March 31, 2013 or December 31, 2012. The fair value measurements of our held-to-maturity debt securities and our short-term borrowings are based on Level 2 inputs, using a market approach. The fair value measurements of our private equity securities at cost are based on Level 3 inputs, using a market approach.


^(g)	Our private equity securities represent investments in the life sciences sector. The increase in 2013 primarily reflects an increased investment in our equity-method investment in China. For additional information, see Note 2D. Acquisitions, Divestitures, Collaborative Arrangement and Equity-Method Investment: Equity-Method Investment.

^(h)

Designated as hedging instruments, except for certain foreign currency contracts used as offsets; namely, foreign currency swaps with fair values of $202 million and foreign currency forward-exchange contracts with fair values of $56 million as of March 31, 2013; and foreign currency forward-exchange contracts with fair values of $141 million and foreign currency swaps with fair values of $129 million as of December 31, 2012.


⁽ⁱ⁾	Some carrying amounts may include adjustments for discount or premium amortization or for the effect of interest rate swaps designated as hedges.


^(j)	Includes foreign currency debt with fair values of $735 million as of March 31, 2013 and $809 million as of December 31, 2012, which are used as hedging instruments.


^(k)	The fair value of our long-term debt (not including the current portion of long-term debt) is $37.8 billion as of March 31, 2013 and $37.5 billion as of December 31, 2012. The fair value measurements for our long-term debt are based on Level 2 inputs, using a market approach.

The following table provides the classification of these selected financial assets and liabilities in the condensed consolidated balance sheets:



(MILLIONS OF DOLLARS)	March 31, 2013		December 31, 2012
Assets
Cash and cash equivalents	$	659	$	1,000
Short-term investments	33,212		22,319
Long-term investments	15,392		14,149
Taxes and other current assets^(a)	367		296
Taxes and other noncurrent assets^(b)	961		1,086
	$	50,591	$	38,850
Liabilities
Short-term borrowings, including current portion of long-term debt	$	8,896	$	6,424
Other current liabilities^(c)	247		330
Long-term debt	31,481		31,036
Other noncurrent liabilities^(d)	701		374
	$	41,325	$	38,164


^(a)	As of March 31, 2013, derivative instruments at fair value include foreign currency forward-exchange contracts ($249 million), interest rate swaps ($64 million), and foreign currency swaps ($54 million) and, as of December 31, 2012, include foreign currency forward-exchange contracts ($152 million) and foreign currency swaps ($144 million).


^(b)	As of March 31, 2013, derivative instruments at fair value include interest rate swaps ($727 million) and foreign currency swaps ($234 million) and, as of December 31, 2012, include interest rate swaps ($1 billion) and foreign currency swaps ($50 million).


^(c)	At March 31, 2013, derivative instruments at fair value include foreign currency swaps ($148 million) and foreign currency forward-exchange contracts ($99 million) and, as of December 31, 2012, include foreign currency forward-exchange contracts ($243 million) and foreign currency swaps ($87 million).


^(d)	At March 31, 2013, derivative instruments at fair value include foreign currency swaps ($675 million) and interest rate swaps ($26 million) and, as of December 31, 2012, include foreign currency swaps ($341 million) and interest rate swaps ($33 million).

In addition, we have long-term receivables where the determination of fair value employs discounted future cash flows, using current interest rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The differences between the estimated fair values and carrying values of these receivables were not significant as of March 31, 2013 or December 31, 2012.

There were no significant impairments of financial assets recognized in any period presented.

B. Investments in Debt Securities

The following table provides the contractual maturities of the available-for-sale and held-to-maturity debt securities:



	Years
			Over 1		Over 5		March 31, 2013
(MILLIONS OF DOLLARS)	Within 1		to 5		to 10		Total
Available-for-sale debt securities
Western European, Canadian and other government debt^(a)	$	19,028	$	2,076	$	—	$	21,104
Corporate debt^(b)	2,165		4,205		1,612		7,982
U.S. government debt	4,023		99		37		4,159
Western European, Scandinavian and other government agency debt^(a)	3,176		433		—		3,609
Federal Home Loan Mortgage Corporation and Federal National Mortgage Association asset-backed securities	—		2,489		178		2,667
Supranational debt^(a)	1,979		688		—		2,667
Reverse repurchase agreements^(c)	1,623		—		—		1,623
Held-to-maturity debt securities
Certificates of deposit and other	1,173		296		1		1,470
Total debt securities	$	33,167	$	10,286	$	1,828	$	45,281


^(a)	All issued by above-investment-grade governments, government agencies or supranational entities, as applicable.


^(b)	Largely issued by above-investment-grade institutions in the financial services sector.


^(c)	Involving U.S. and U.K. government securities.

C. Short-Term Borrowings

Short-term borrowings include amounts for commercial paper of $2.7 billion as of March 31, 2013 and December 31, 2012. Additionally, on February 6, 2013, Zoetis entered into a commercial paper program with a capacity of up to $1.0 billion; no amounts are currently outstanding under that program.

D. Long-Term Debt

On January 28, 2013, our then wholly owned subsidiary, Zoetis, issued $3.65 billion aggregate principal amount of senior notes, net of an original issue debt discount of $10 million. For additional information, see Note 2B. Acquisitions, Divestitures, Collaborative Arrangement and Equity-Method Investment: Divestitures.

In the first quarter of 2013, we also reclassified approximately $2.5 billion of long-term debt into Short-term borrowings, including current portion of long-term debt.

The following table provides the components of the Zoetis senior unsecured long-term debt issued in the first quarter of 2013, net of unamortized discounts:



		As of
		March 31,
(MILLIONS OF DOLLARS)	Maturity Date	2013
3.250%	February 2023	$	1,349
4.700%	February 2043	1,142
1.875%	February 2018	749
1.150%	February 2016	400
Total long-term debt issued in the first quarter of 2013^{(a), (b)}		$	3,640


^(a)	For additional information, see Note 2B. Acquisitions, Divestitures, Collaborative Arrangement and Equity-Method Investment: Divestitures.

^(b)

The indenture that governs the Zoetis senior notes contains covenants, including limitations on the ability of Zoetis and certain Zoetis subsidiaries to incur liens or engage in sale-leaseback transactions. The indenture also contains restrictions on Zoetis' ability to consolidate, merge or sell substantially all of its assets. In addition, the indenture contains other customary terms, including certain events of default, upon the occurrence of which, the Zoetis senior notes may be declared immediately due and payable. Zoetis is able to redeem the Zoetis senior notes, in whole or in part, at any time by paying a “make whole” premium, plus accrued and unpaid interest. Except under limited circumstances, Zoetis will not be permitted to redeem the 2023 notes pursuant to this optional redemption provision. Upon the occurrence of a change of control of Zoetis and a downgrade of the senior notes below an investment grade rating by each of Moody's Investors Service, Inc. and Standard & Poor's Ratings Services, Zoetis is, in certain circumstances, required to make an offer to purchase each of the Zoetis senior notes at a price equal to 101% of the aggregate principal amount of the Zoetis senior notes together with accrued and unpaid interest.

The following table provides the maturity schedule of our Long-term debt outstanding as of March 31, 2013:



(MILLIONS OF DOLLARS)	2014		2015		2016		2017		After 2017		Total
Maturities	$	1,251	$	3,057	$	4,706	$	1,850	$	20,617	$	31,481

E. Derivative Financial Instruments and Hedging Activities

Foreign Exchange Risk

As of March 31, 2013, the aggregate notional amount of foreign exchange derivative financial instruments hedging or offsetting foreign currency exposures is $42.4 billion. The derivative financial instruments primarily hedge or offset exposures in the euro, U.K. pound, Japanese yen and Canadian dollar. The maximum length of time over which we are hedging future foreign exchange cash flow relates to our $2.3 billion U.K. pound debt maturing in 2038.

Interest Rate Risk

As of March 31, 2013, the aggregate notional amount of interest rate derivative financial instruments is $11.7 billion. The derivative financial instruments primarily hedge U.S. dollar and euro fixed-rate debt.

The following table provides information about the gains/(losses) recognized to hedge or offset operational foreign exchange or interest rate risk:



	Amount of Gains/(Losses) Recognized in OID^{(a), (b), (c)}						Amount of Gains/(Losses) Recognized in OCI (Effective Portion)^{(a), (d)}					Amount of Gains/(Losses) Reclassified from OCI into OID (Effective Portion)^{(a), (d)}
(MILLIONS OF DOLLARS)	Mar 31, 2013			Apr 1, 2012			Mar 31, 2013			Apr 1, 2012		Mar 31, 2013			Apr 1, 2012
Three Months Ended
Derivative Financial Instruments in Cash Flow Hedge Relationships:
Foreign currency swaps	$	—		$	—		$	(417	)	$	428	$	(381	)	$	300

Derivative Financial Instruments in Net Investment Hedge Relationships:
Foreign currency swaps	(3		)	(1		)	123			125		—			—

Derivative Financial Instruments Not Designated as Hedges:
Foreign currency forward-exchange contracts	149			(127		)	—			—		—			—
Foreign currency swaps	(4		)	(23		)	—			—		—			—

Non-Derivative Financial Instruments in Net Investment Hedge Relationships:
Foreign currency long-term debt	—			—			63			50		—			—
All other net	—			(1		)	—			9		—			—
	$	142		$	(152	)	$	(231	)	$	612	$	(381	)	$	300


^(a)	OID = Other (income)/deductions—net, included in Other deductions—net in the condensed consolidated statements of income. OCI = Other comprehensive income/(loss), included in the condensed consolidated statements of comprehensive income.


^(b)	Also includes gains and losses attributable to the hedged risk in fair value hedge relationships.


^(c)	There was no significant ineffectiveness for any period presented.

^(d)

Amounts presented represent the effective portion of the gain or loss. For derivative financial instruments in cash flow hedge relationships, the effective portion is included in Other comprehensive income/(loss)––Unrealized holding gains/(losses) on derivative financial instruments. For derivative financial instruments in net investment hedge relationships and for foreign currency debt designated as hedging instruments, the effective portion is included in Other comprehensive income/(loss)––foreign currency translation adjustments.

For information about the fair value of our derivative financial instruments, and the impact on our condensed consolidated balance sheets, see Note 7A. Financial Instruments: Selected Financial Assets and Liabilities above. Certain of our derivative instruments are covered by associated credit-support agreements that have credit-risk-related contingent features designed to reduce our counterparties’ exposure to our risk of defaulting on amounts owed. As of March 31, 2013, the aggregate fair value of these derivative instruments that are in a net liability position is $178 million, for which we have posted collateral of $105 million in the normal course of business. These features include the requirement to pay additional collateral in the event of a downgrade in our debt ratings. If there had been a downgrade to below an A rating by S&P or the equivalent rating by Moody’s Investors Service, on March 31, 2013, we would have been required to post an additional $73 million of collateral to our counterparties. The collateral advanced receivables are reported in Cash and cash equivalents.

F. Credit Risk

On an ongoing basis, we review the creditworthiness of counterparties to our foreign exchange and interest rate agreements and do not expect to incur a significant loss from failure of any counterparties to perform under the agreements. There are no significant concentrations of credit risk related to our financial instruments with any individual counterparty. As of March 31, 2013, we had $2.9 billion due from a well-diversified, highly rated group (S&P ratings of mostly A+ or better) of bank counterparties around the world. For details about our investments, see Note 7B. Financial Instruments: Investments in Debt Securities.

In general, there is no requirement for collateral from customers. However, derivative financial instruments are executed under master netting agreements with financial institutions. These agreements contain provisions that provide for the ability for collateral payments, depending on levels of exposure, our credit rating and the credit rating of the counterparty. As of March 31, 2013, we received cash collateral of $729 million against various counterparties. The collateral primarily supports the approximate fair value of our derivative contracts. With respect to the collateral received, which is included in Cash and cash equivalents, the obligations are reported in Short-term borrowings, including current portion of long-term debt.