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)	July 3, 2016			December 31, 2015
Selected financial assets measured at fair value on a recurring basis^(a)
Trading funds^(b)	$	240		$	287
Available-for-sale debt securities^(c)	27,374			32,078
Money market funds	1,113			934
Available-for-sale equity securities^(c)	584			603
Derivative financial instruments in a receivable position^(d):
Interest rate swaps	1,978			837
Foreign currency swaps	92			135
Foreign currency forward-exchange contracts	188			559
	31,569			35,433
Other selected financial assets
Held-to-maturity debt securities, carried at amortized cost^{(c), (e)}	1,166			1,388
Private equity securities, carried at equity-method or at cost^(e), ^(f)	1,027			1,336
	2,193			2,724
Total selected financial assets	$	33,762		$	38,157
Selected financial liabilities measured at fair value on a recurring basis^(a)
Derivative financial instruments in a liability position^(g):
Interest rate swaps	$	4		$	139
Foreign currency swaps	1,432			1,489
Foreign currency forward-exchange contracts	366			81
	1,802			1,709
Other selected financial liabilities
Short-term borrowings:
Principal amount	13,442			10,160
Net fair value adjustments related to hedging and purchase accounting	290			2
Net unamortized discounts, premiums and debt issuance costs^(h)	(8		)	(3		)
Total short-term borrowings, carried at historical proceeds, as adjusted^(e)	13,724			10,159
Long-term debt:
Principal amount	28,113			27,573
Net fair value adjustments related to hedging and purchase accounting	2,432			1,294
Net unamortized discounts, premiums and debt issuance costs^(h)	(87		)	(127		)
Total long-term debt, carried at historical proceeds, as adjusted⁽ⁱ⁾	30,457			28,740
	44,181			38,899
Total selected financial liabilities	$	45,983		$	40,608


^(a)	We use a market approach in valuing financial instruments on a recurring basis. For additional information, see Note 1C. 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 inputs and money market funds measured at net asset value.

^(b)

As of July 3, 2016, trading funds are composed of $184 million of trading equity funds and $57 million of trading debt funds. As of December 31, 2015, trading funds are composed of $185 million of trading equity funds and $102 million of trading debt funds. As of July 3, 2016 and December 31, 2015, trading equity funds of $66 million and $85 million, respectively, are held in trust for benefits attributable to the former Pharmacia Savings Plus Plan.


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


^(d)	Designated as hedging instruments, except for certain contracts used as offsets; namely, foreign currency forward-exchange contracts with fair values of $77 million as of July 3, 2016; and foreign currency forward-exchange contracts with fair values of $136 million as of December 31, 2015.

^(e)

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 July 3, 2016 or December 31, 2015. 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 carried at cost are based on Level 3 inputs. Short-term borrowings include foreign currency short-term borrowings with fair values of $547 million as of December 31, 2015, which are used as hedging instruments.


^(f)	Our private equity securities represent investments in the life sciences sector.

^(g)

Designated as hedging instruments, except for certain contracts used as offsets; namely, foreign currency swaps with fair values of $213 million and foreign currency forward-exchange contracts with fair values of $116 million as of July 3, 2016; and foreign currency swaps with fair values of $234 million and foreign currency forward-exchange contracts with fair values of $59 million as of December 31, 2015.


^(h)	We adopted a new standard as of January 1, 2016 that changed the presentation of debt issuance costs related to a recognized debt liability as a direct deduction from the carrying value of that associated debt, consistent with the presentation of a debt discount. See Note 1B for additional information.

⁽ⁱ⁾

The fair value of our long-term debt (not including the current portion of long-term debt) was $34.6 billion as of July 3, 2016 and $32.7 billion as of December 31, 2015. The fair value measurements for our long-term debt are based on Level 2 inputs, using a market approach. Generally, the difference between the fair value of our long-term debt and the amount reported on the condensed consolidated balance sheet is due to a decline in relative market interest rates since the debt issuance.



The following table provides the classification of these selected financial assets and liabilities in our condensed consolidated balance sheets:
(MILLIONS OF DOLLARS)	July 3, 2016		December 31, 2015
Assets
Cash and cash equivalents	$	848	$	978
Short-term investments	17,531		19,649
Long-term investments	13,124		15,999
Other current assets^(a)	304		587
Other noncurrent assets^(b)	1,954		944
	$	33,762	$	38,157
Liabilities
Short-term borrowings, including current portion of long-term debt^(c)	$	13,724	$	10,159
Other current liabilities^(d)	606		645
Long-term debt^(c)	30,457		28,740
Other noncurrent liabilities^(e)	1,196		1,064
	$	45,983	$	40,608


^(a)	As of July 3, 2016, derivative instruments at fair value include interest rate swaps ($58 million), foreign currency swaps ($71 million) and foreign currency forward-exchange contracts ($175 million) and, as of December 31, 2015, include interest rate swaps ($2 million), foreign currency swaps ($46 million) and foreign currency forward-exchange contracts ($538 million).


^(b)	As of July 3, 2016, derivative instruments at fair value include interest rate swaps ($1.9 billion), foreign currency swaps ($21 million) and foreign currency forward-exchange contracts ($14 million) and, as of December 31, 2015, include interest rate swaps ($835 million), foreign currency swaps ($89 million) and foreign currency forward-exchange contracts ($20 million).


^(c)	We adopted a new standard as of January 1, 2016 that changed the presentation of debt issuance costs related to a recognized debt liability as a direct deduction from the carrying value of that associated debt, consistent with the presentation of a debt discount. See Note 1B for additional information.


^(d)	As of July 3, 2016, derivative instruments at fair value include interest rate swaps ($3 million), foreign currency swaps ($265 million) and foreign currency forward-exchange contracts ($338 million) and, as of December 31, 2015, include interest rate swaps ($5 million), foreign currency swaps ($560 million) and foreign currency forward-exchange contracts ($80 million).


^(e)	As of July 3, 2016, derivative instruments at fair value include interest rate swaps ($1 million), foreign currency swaps ($1.2 billion) and foreign currency forward-exchange contracts ($28 million) and, as of December 31, 2015, include interest rate swaps ($134 million), foreign currency swaps ($928 million) and foreign currency forward-exchange contracts ($1 million).

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, or as necessary, the estimated maturities, of the available-for-sale and held-to-maturity debt securities:
	Years								July 3, 2016
(MILLIONS OF DOLLARS)	Within 1		Over 1 to 5		Over 5 to 10		Over 10		Total
Available-for-sale debt securities
Corporate debt^(a)	$	4,136	$	4,623	$	1,707	$	33	$	10,499
Western European, Asian, Scandinavian and other government debt^(b)	7,063		666		8		—		7,738
Federal Home Loan Mortgage Corporation and Federal National Mortgage Association asset-backed securities	78		2,196		58		—		2,332
U.S. government debt	1,302		508		210		—		2,020
Western European, Scandinavian and other government agency debt^(b)	1,700		162		—		—		1,862
Supranational debt^(b)	804		375		—		—		1,179
Other asset-backed debt^(c)	411		592		31		3		1,037
Government National Mortgage Association and other U.S. government guaranteed asset-backed securities	620		69		17		—		706
Held-to-maturity debt securities
Time deposits and other	1,149		1		—		—		1,151
Western European government debt^(b)	15		—		—		—		15
Total debt securities	$	17,279	$	9,193	$	2,031	$	36	$	28,539


^(a)	Issued by a diverse group of corporations, largely consisting of financial institutions, virtually all of which are investment-grade.


^(b)	Issued by governments, government agencies or supranational entities, as applicable, all of which are investment-grade.

^(c)

Includes loan-backed, receivable-backed, and mortgage-backed securities, all of which are investment-grade and in senior positions in the capital structure of the security. Loan-backed securities are collateralized by senior secured obligations of a diverse pool of companies or student loans, and receivable-backed securities are collateralized by credit cards receivables. Mortgage-backed securities are collateralized by diversified pools of residential and commercial mortgages. These securities are valued by third party models that use significant inputs derived from observable market data like prepayment rates, default rates, and recovery rates.

C. Short-Term Borrowings

Short-term borrowings include amounts for commercial paper of $8.0 billion as of July 3, 2016 and $4.9 billion as of December 31, 2015.

Our short-term debt increased due to the addition of legacy Anacor debt, recorded at the June 24, 2016 acquisition date fair value of $698 million. This debt is redeemable into cash at that amount by August 12, 2016, and otherwise redeemable through the maturity date by the note holders in accordance with the terms of the relevant indenture. As of July 3, 2016, $239 million of the debt has been redeemed.



The following table provides the components of unsecured short-term debt assumed from Anacor:
(MILLIONS OF DOLLARS)	As of July 3, 2016
2.00% Notes (Maturity Date 2021)	$	184
2.00% Notes (Maturity Date 2023)	275
Total short-term debt assumed from Anacor	$	459

D. Long-Term Debt

On June 3, 2016, we completed a public offering of $5.0 billion aggregate principal amount of senior unsecured notes. The notes are redeemable, in whole or in part, at any time at our option, at a redemption price equal to the greater of 100% of the principal amount of the notes or the sum of the present value of the remaining scheduled payments of principal and interest discounted at the U.S. Treasury rate, plus an incremental spread ranging between 0.5% and 0.15%, depending on the maturity; plus, in each case, accrued and unpaid interest. Interest is payable semi-annually.



The following table provides the principal amounts and components of unsecured long-term debt issued in the second quarter of 2016:
(MILLIONS OF DOLLARS)	Maturity Date	As of July 3, 2016
1.20% Notes (2018 Notes)	June 1, 2018	$	1,250
1.45% Notes (2019 Notes)	June 3, 2019	850
1.95% Notes (2021 Notes)	June 3, 2021	1,150
2.75% Notes (2026 Notes)	June 3, 2026	1,250
4.40% Notes (2044 Notes)	May 15, 2044	500
Total long-term debt issued in the second quarter of 2016		$	5,000



The following table provides the maturity schedule of our Long-term debt outstanding as of July 3, 2016:
(MILLIONS OF DOLLARS)	2017		2018		2019		2020		After 2020		Total
Maturities	$	—	$	3,628	$	5,710	$	385	$	20,735	$	30,457

E. Derivative Financial Instruments and Hedging Activities

Foreign Exchange Risk

As of July 3, 2016, the aggregate notional amount of foreign exchange derivative financial instruments hedging or offsetting foreign currency exposures was $31.5 billion. The derivative financial instruments primarily hedge or offset exposures in the euro, Japanese yen and U.K. pound. The maximum length of time over which we are hedging future foreign exchange cash flow relates to our 2.0 billion U.K. pound debt maturing in 2038.

Interest Rate Risk

As of July 3, 2016, the aggregate notional amount of interest rate derivative financial instruments was $19.7 billion. The derivative financial instruments primarily hedge U.S. dollar and euro fixed-rate debt.



The following table provides information about the gains/(losses) incurred to hedge or offset operational foreign exchange or interest rate risk:
	Three Months Ended
	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)	July 3, 2016			June 28, 2015			July 3, 2016			June 28, 2015			July 3, 2016			June 28, 2015
Derivative Financial Instruments in Cash Flow Hedge Relationships:
Foreign currency swaps	$	—		$	—		$	(345	)	$	234		$	(243	)	$	240
Foreign currency forward-exchange contracts	(2		)	—			(227		)	204			(226		)	502
Derivative Financial Instruments in Net Investment Hedge Relationships:
Foreign currency forward-exchange contracts	3			—			(3		)	10			—			—

Derivative Financial Instruments Not Designated as Hedges:
Foreign currency forward-exchange contracts	(46		)	(73		)	—			—			—			—
Foreign currency swaps	(3		)	(2		)	—			—			—			—

Non-Derivative Financial Instruments in Net Investment Hedge Relationships:
Foreign currency short-term borrowings	—			—			—			21			—			—
All other net	—			—			—			14			—			—
	$	(48	)	$	(75	)	$	(575	)	$	483		$	(470	)	$	743

	Six Months Ended
	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)	July 3, 2016			June 28, 2015			July 3, 2016			June 28, 2015			July 3, 2016			June 28, 2015
Derivative Financial Instruments in Cash Flow Hedge Relationships:
Foreign currency swaps	$	—		$	—		$	(290	)	$	(498	)	$	(126	)	$	(365	)
Foreign currency forward-exchange contracts	(1		)	—			(558		)	621			(8		)	875
Derivative Financial Instruments in Net Investment Hedge Relationships:
Foreign currency forward-exchange contracts	1			2			(15		)	259			—			—

Derivative Financial Instruments Not Designated as Hedges:
Foreign currency forward-exchange contracts	(69		)	(113		)	—			—			—			—
Foreign currency swaps	(4		)	(2		)	—			—			—			—

Non-Derivative Financial Instruments in Net Investment Hedge Relationships:
Foreign currency short-term borrowings	—			—			(26		)	19			—			—
All other net	—			—			—			14			—			—
	$	(73	)	$	(113	)	$	(889	)	$	416		$	(134	)	$	510


^(a)	OID = Other (income)/deductions—net, included in Other (income)/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 derivative instruments designated and qualifying as fair value hedges, as well as the offsetting gains and losses attributable to the hedged items in such hedging relationships.


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

^(d)

For derivative financial instruments in cash flow hedge relationships, the effective portion is included in Other comprehensive income/(loss)––Unrealized holding losses on derivative financial instruments, net. 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, net.

For information about the fair value of our derivative financial instruments, and the impact on our condensed consolidated balance sheets, see Note 7A 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 July 3, 2016, the aggregate fair value of these derivative instruments that are in a net liability position was $805 million, for which we have posted collateral of $806 million in the normal course of business. If there had been a downgrade to below an A rating by S&P or the equivalent rating by Moody’s, on July 3, 2016, we would have been required to post an additional $4 million of collateral to our counterparties. The collateral advanced receivables are reported in Short-term investments.

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 July 3, 2016, we had $2.1 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 above.

In general, there is no requirement for collateral from customers. However, derivative financial instruments are executed under credit-support agreements that provide for the ability to request collateral payments depending on levels of exposure. As of July 3, 2016, we received cash collateral of $859 million from various counterparties. The collateral primarily supports the approximate fair value of our derivative contracts. With respect to the collateral received, the obligations are reported in Short-term borrowings, including current portion of long-term debt.