Financial Instruments, Hedging Activities and Fair Value Measurements

Financial instruments include cash and cash equivalents, short-term investments, cash held in escrow, marketable equity securities, accounts receivable, company-owned life insurance, accounts payable, short-term and long-term debt instruments, and derivatives. The fair values of these financial instruments approximated their carrying values at September 30, 2014 and December 31, 2013, in the aggregate, except for long-term debt instruments.

Hedging Activities

The Company has exposure to market risk from changes in foreign currency rates, PPG's stock price and interest rates. As a result, certain derivative financial instruments may be used when available on a cost effective basis to hedge the underlying economic exposure. Certain of these instruments qualify as cash flow, fair value and net investment hedges upon meeting the requisite criteria, including effectiveness of offsetting hedge exposures. Changes in the fair value of derivatives that do not qualify for hedge accounting are recognized in income from continuing operations in the period incurred.

Fair Value Hedges

PPG designates forward currency contracts as hedges against the Company’s exposure to future changes in fair value of certain firm sales commitments denominated in foreign currencies. Interest rate swaps have been used from time to time to manage the Company's exposure to changing interest rates. When outstanding, the interest rate swaps were designated as fair value hedges and were recorded at fair value. In prior years, PPG settled interest rate swaps and received cash. There were no interest rate swaps outstanding as of September 30, 2014 and December 31, 2013. However, the fair value adjustment of the debt at the time the interest rates swaps were settled is still being amortized as a reduction to interest expense over the remaining term of the related debt.

PPG has entered into renewable equity forward arrangements to hedge the impact to PPG's income from continuing operations for changes in the fair value of 1,388,889 shares of PPG stock that are to be contributed to the asbestos settlement trust as discussed in Note 15, “Commitments and Contingent Liabilities.” This financial instrument is recorded at fair value as an asset or liability and changes in the fair value of this financial instrument are reflected in the “Asbestos settlement – net” caption of the accompanying condensed consolidated statement of income. The total principal amount payable for these shares is $62 million. PPG will pay to the counterparty interest based on the principal amount and the counterparty will pay to PPG an amount equal to the dividends paid on these shares during the period this financial instrument is outstanding. The difference between the principal amount and any amounts related to unpaid interest or dividends and the current market price for these shares, adjusted for credit risk, represents the fair value of the financial instrument as well as the amount that PPG would pay or receive if the counterparty chose to net settle the financial instrument. Alternatively, the bank may, at its option, require PPG to purchase the shares covered by the arrangement at the principal amount adjusted for unpaid interest and dividends as of the date of settlement. As of September 30, 2014 and December 31, 2013, the fair value of this contract was an asset of $218 million and $207 million, respectively.

Cash Flow Hedges

PPG designates certain foreign currency forward contracts and forward starting swaps as cash flow hedges of the Company’s exposure to variability in exchange rates on intercompany and third party transactions denominated in foreign currencies and interest rates. As of September 30, 2014 and December 31 2013, the fair value of all foreign currency forward contracts designated as cash flow hedges was a net asset of $14 million and $8 million, respectively.

The Company entered into forward starting swaps in 2009 and 2010 to effectively lock-in a fixed interest rate for future debt refinancings with an anticipated term of ten years based on the ten year swap rate, to which was added a corporate spread. The swaps had a total notional amount of $400 million and were settled on July 30, 2012, resulting in a cash payment of $121 million, which is being amortized to interest expense over the remaining term of the ten-year debt. As of September 30, 2014, the amount of loss recorded in AOCI was $95 million.

Net Investment Hedges

PPG uses cross currency swaps, foreign currency forward contracts and euro-denominated debt to hedge a portion of its net investment in its European coatings operations. In 2008, PPG entered into U.S. dollar to euro cross currency swap contracts with a total notional amount of $1.16 billion, of which $600 million of contracts were settled in June 2012 with PPG receiving $1 million in cash. The remaining outstanding contracts of $560 million are expected to be settled in March 2018. On settlement of the remaining outstanding contracts, PPG will receive $560 million U.S. dollars and pay euros to the counterparties to the contracts. During the term of these contracts, PPG will receive semiannual payments in March and September of each year based on U.S. dollar, long-term fixed interest rates, and PPG will make annual payments in March of each year to the counterparties based on euro, long-term fixed interest rates. As of September 30, 2014 and December 31, 2013, the fair value of these contracts was a net liability of $66 million and $120 million, respectively.

At September 30, 2014 and December 31, 2013, PPG had €300 million of euro-denominated borrowings designated as a net investment hedge of a portion of the Company's European operations. The fair value of these instruments at September 30, 2014 and December 31, 2013 was $388 million and $429 million, respectively.

As of September 30, 2014, PPG had approximately $488 million of foreign currency forward contracts outstanding that hedged an additional portion of its net investment in its European coatings operations. The fair value of these instruments was an asset of $9 million at September 30, 2014.

As of September 30, 2014 and December 31, 2013, the Company had accumulated pre-tax unrealized translation gains in AOCI of $90 million and losses of $35 million related to the euro-denominated borrowings, foreign currency forward contracts and the cross currency swaps.

PPG’s policies do not permit speculative use of derivative financial instruments. PPG enters into derivative financial instruments with high credit quality counterparties and diversifies its positions among such counterparties in order to reduce its exposure to credit losses. The Company did not realize a credit loss on derivatives during the three and nine-month periods ended September 30, 2014 and 2013.

All of PPG's outstanding derivative instruments are subject to accelerated settlement in the event of PPG’s failure to meet its debt or payment obligations under the terms of the instruments’ contractual provisions. In addition, should the Company be acquired and its payment obligations under the derivative instruments’ contractual arrangements not be assumed by the acquirer, or should PPG enter into bankruptcy, receivership or reorganization proceedings, the instruments would also be subject to accelerated settlement.

No derivative instrument initially designated as a hedge instrument was undesignated or discontinued as a hedging instrument during the three and nine-month periods ended September 30, 2014 and 2013. In addition, no amounts deferred in AOCI were reclassified to income from continuing operations during the three and nine-month periods ended September 30, 2014 and 2013 related to hedges of anticipated transactions that were no longer expected to occur.

The following table provides details for the nine months ended September 30, 2014 related to PPG's hedging activities. All dollar amounts are shown on a pre-tax basis.



($ in Millions)	September 30, 2014
Hedge Type	Gain (Loss) Deferred in OCI		Gain (Loss) Recognized
Hedge Type	Gain (Loss) Deferred in OCI		Amount			Caption
Fair Value
Interest rate swaps	Not applicable		$	6		Interest expense
Foreign currency forward contracts	Not applicable		1			Net sales
Equity forward arrangements	Not applicable		11			Asbestos - net
Total Fair Value			$	18
Cash Flow
Forward starting swaps	—		$	(9	)	Interest expense
Foreign currency forward contracts ^(a)	23		24			Other charges
Total Cash Flow	$	23	$	15
Net Investment
Cross currency swaps	$	47	$	—		Other charges
Foreign currency forward contracts	45		—			Other charges
Foreign denominated debt	33		Not applicable
Total Net Investment	$	125	$	—

(a) The ineffective portion related to this item was $5 million of expense.

The following table provides details for the nine months ended September 30, 2013 related to PPG's hedging activities. All amounts are shown on a pre-tax basis:



($ in Millions)	September 30, 2013
Hedge Type	Gain (Loss) Deferred in OCI			Gain (Loss) Recognized
Hedge Type	Gain (Loss) Deferred in OCI			Amount			Caption
Fair Value
Interest rate swaps	Not applicable			$	7		Interest expense
Foreign currency forward contracts	Not applicable			1			Net sales
Equity forward arrangements	Not applicable			46			Asbestos - net
Total Fair Value				$	54
Cash Flow
Forward starting swaps	—			(9		)	Interest expense
Foreign currency forward contracts ^(a)	29			30			Other charges
Total Cash Flow	$	29		$	21
Net Investment
Cross currency swaps	$	(15	)	$	—
Foreign denominated debt	(10		)	Not applicable
Total Net Investment	$	(25	)	$	—

(a) The ineffective portion related to this item was $6 million of expense.

Fair Value Measurements

The Company follows a fair value measurement hierarchy to measure its assets and liabilities. As of September 30, 2014 and December 31, 2013, the assets and liabilities measured at fair value on a recurring basis were cash equivalents, equity securities and derivatives. In addition, the Company measures its pension plan assets at fair value (see Item 8. Financial Statements and Supplementary Data - Note 13, "Pensions and Other Postretirement Benefits" in the Company's 2013 Annual Report on Form 10-K for further details). The Company's financial assets and liabilities are measured using inputs from the following three levels:

Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets and liabilities that the Company has the ability to access at the measurement date. Level 1 inputs are considered to be the most reliable evidence of fair value as they are based on unadjusted quoted market prices from various financial information service providers and securities exchanges.

Level 2 inputs are directly or indirectly observable prices that are not quoted on active exchanges, which include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability and inputs that are derived principally from or corroborated by observable market data by correlation or other means. The fair values of these derivative instruments reflect the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including forward curves.

Level 3 inputs are unobservable inputs employed for measuring the fair value of assets or liabilities. The Company does not have any recurring financial assets or liabilities that are recorded in its consolidated balance sheets as of September 30, 2014 and December 31, 2013 that are classified as Level 3 inputs.

Assets and liabilities reported at fair value on a recurring basis:



	September 30, 2014
($ in Millions)	Level 1		Level 2		Level 3
Assets:
Other current assets:
Marketable equity securities	$	5	$	—	$	—
Foreign currency forward contracts	—		39		—
Equity forward arrangement	—		218		—
Investments:
Marketable equity securities	73		—		—
Other Assets:
Foreign currency forward contracts	—		9		—
Liabilities:
Accounts payable and accrued liabilities:
Foreign currency forward contracts	—		24		—
Other liabilities:
Cross currency swaps	—		66		—

	December 31, 2013
($ in Millions)	Level 1		Level 2		Level 3
Assets:
Short-term investments:
Commercial paper and certificates of deposit	$	—	$	50	$	—
Other current assets:
Marketable equity securities	5		—		—
Foreign currency forward contracts	—		25		—
Equity forward arrangement	—		207		—
Investments:
Marketable equity securities	70		—		—
Other assets:
Foreign currency forward contracts	—		2		—
Liabilities:
Accounts payable and accrued liabilities:
Foreign currency forward contracts	—		7		—
Other liabilities:
Cross currency swaps	—		120		—
Foreign currency forward contracts	—		11		—

Long-Term Debt

PPG's long-term debt (excluding capital lease obligations) had carrying and fair values totaling $3,307 million and $3,720 million, respectively, as of September 30, 2014. Long-term debt (excluding capital lease obligations) had carrying and fair values totaling $3,346 million and $3,683 million, respectively, as of December 31, 2013. The fair values of the debt instruments were based on discounted cash flows and interest rates then currently available to the Company for instruments of the same remaining maturities and were measured using level 2 inputs.

Assets and liabilities reported at fair value on a nonrecurring basis:

There were no significant adjustments to the fair value of nonmonetary assets or liabilities during the nine months ended September 30, 2014, or for the year ended December 31, 2013.