Note 9. Financial Instruments

A. Selected Financial Assets and Liabilities

Information about certain of our financial assets and liabilities follows:

(millions of dollars)	July 3, 2011		Dec. 31, 2010
Selected financial assets measured at fair value on a recurring basis (a) :
Trading securities	$	157	$	173
Available-for-sale debt securities(b)		29,558		32,699
Available-for-sale money market funds		1,141		1,217
Available-for-sale equity securities, excluding money market funds(b)		327		230
Derivative financial instruments in receivable positions(c):
Interest rate swaps		609		603
Foreign currency swaps		457		128
Foreign currency forward-exchange contracts		103		494
Total		32,352		35,544
Other selected financial assets(d):
Held-to-maturity debt securities, carried at amortized cost(b)		781		1,178
Private equity securities, carried at cost or equity method		1,046		1,134
Short-term loans, carried at cost		462		467
Long-term loans, carried at cost		182		299
Total		2,471		3,078
Total selected financial assets (e)	$	34,823	$	38,622
Financial liabilities measured at fair value on a recurring basis(a):
Derivative financial instruments in a liability position(f):
Foreign currency swaps	$	540	$	623
Foreign currency forward-exchange contracts		393		257
Interest rate swaps		5		4
Total		938		884
Other financial liabilities:
Short-term borrowings, carried at historical proceeds, as adjusted(d)		5,988		5,603
Long-term debt, carried at historical proceeds, as adjusted(g), (h)		35,723		38,410
Total		41,711		44,013
Total selected financial liabilities	$	42,649	$	44,897

(a)

Fair values are determined based on valuation techniques categorized as follows: Level 1 means the use of quoted prices for identical instruments in active markets; Level 2 means the use of quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active or are directly or indirectly observable; Level 3 means the use of unobservable inputs. 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 that included in available-for-sale equity securities, excluding money market funds, are $111 million as of July 3, 2011 and $105 million as of December 31, 2010 of investments that use Level 1 inputs in the calculation of fair value, and $48 million that use Level 3 inputs as of July 3, 2011.

(b)	Gross unrealized gains and losses are not significant.

(c)

Designated as hedging instruments, except for certain foreign currency contracts used as offsets; namely, foreign currency swaps with fair values of $107 million and foreign currency forward-exchange contracts with fair values of $73 million at July 3, 2011; and foreign currency forward-exchange contracts with fair values of $326 million and foreign currency swaps with fair values of $17 million at December 31, 2010.

(d)	The differences between the estimated fair values and carrying values of our financial assets and liabilities not measured at fair value on a recurring basis were not significant at July 3, 2011 or December 31, 2010.

(e)	The decrease in selected financial assets is primarily due to redemptions of investments, the proceeds from which were used to fund our acquisition of King (see Note 3. Acquisition of King Pharmaceuticals, Inc.)

(f)

Designated as hedging instruments, except for certain foreign currency contracts used as offsets; namely, foreign currency forward-exchange contracts with fair values of $41 million and foreign currency swaps with fair values of $1 million at July 3, 2011; and foreign currency forward-exchange contracts with fair values of $186 million and foreign currency swaps with fair values of $93 million at December 31, 2010.

(g)	Includes foreign currency debt with fair values of $881 million at July 3, 2011 and $880 million at December 31, 2010, which are used to hedge the exposure of certain foreign currency denominated net investments.

(h)	The fair value of our long-term debt is $39.2 billion at July 3, 2011 and $42.3 billion at December 31, 2010.

These selected financial assets and liabilities are presented in the Condensed Consolidated Balance Sheets as follows:

(millions of dollars)	July 3, 2011		Dec. 31, 2010
Assets
Cash and cash equivalents	$	597	$	906
Short-term investments		22,388		26,277
Short-term loans		462		467
Long-term investments and loans		10,207		9,747
Taxes and other current assets(a)		321		515
Taxes and other noncurrent assets(b)		848		710
Total selected financial assets	$	34,823	$	38,622
Liabilities
Short-term borrowings, including current portion of long-term debt	$	5,988	$	5,603
Other current liabilities(c)		606		339
Long-term debt		35,723		38,410
Other noncurrent liabilities(d)		332		545
Total selected financial liabilities	$	42,649	$	44,897

(a)

At July 3, 2011, derivative instruments at fair value include foreign currency swaps ($147 million), foreign currency forward-exchange contracts ($103 million) and interest rate swaps ($71 million) and at December 31, 2010, include foreign currency forward-exchange contracts ($494 million) and foreign currency swaps ($21 million).

(b)	At July 3, 2011, derivative instruments at fair value include interest rate swaps ($538 million) and foreign currency swaps ($310 million) and at December 31, 2010, include interest rate swaps ($603 million) and foreign currency swaps ($107 million).

(c)

At July 3, 2011, derivative instruments at fair value include foreign currency forward-exchange contracts ($393 million) and foreign currency swaps ($213 million) and at December 31, 2010, include foreign currency forward-exchange contracts ($257 million), foreign currency swaps ($79 million) and interest rate swaps ($3 million).

(d)	At July 3, 2011, derivative instruments at fair value include foreign currency swaps ($327 million) and interest rate swaps ($5 million) and at December 31, 2010, include foreign currency swaps ($544 million) and interest rate swaps ($1 million).

There were no significant impairments of financial assets recognized in the second quarter and first six months of 2011 or 2010.

B. Investments in Debt Securities

The contractual maturities of the available-for-sale and held-to-maturity debt securities at July 3, 2011, follow:

	Years
(millions of dollars)	Within 1		Over 1 to 5		Over 10		Total at July 3, 2011
Available-for-sale debt securities:
Western European and other government debt	$	14,758	$	1,343	$	17	$	16,118
Corporate debt		1,251		2,745		––		3,996
Federal Home Loan Mortgage Corporation and Federal National Mortgage Association asset-backed securities		––		2,310		––		2,310
Western European and other government agency debt		2,704		397		––		3,101
Supranational debt		1,401		708		––		2,109
Reverse repurchase agreements		1,154		––		––		1,154
U.S. government Federal Deposit Insurance Corporation guaranteed debt		373		278		––		651
Other asset-backed securities		5		28		30		63
Certificates of deposit		56		––		––		56
Held-to-maturity debt securities:
Certificates of deposit and other		775		6		––		781
Total debt securities	$	22,477	$	7,815	$	47	$	30,339

C. Short-Term Borrowings

Short-term borrowings include amounts for commercial paper of $600 million as of July 3, 2011 and $1.2 billion as of December 31, 2010.

D. Derivative Financial Instruments and Hedging Activities

Foreign Exchange Risk—As of July 3, 2011, the aggregate notional amount of foreign exchange derivative financial instruments hedging or offsetting foreign currency exposures is $46.8 billion. The derivative financial instruments primarily hedge or offset exposures in euro, Japanese yen and U.K. pound.

Interest Rate Risk—As of July 3, 2011, the aggregate notional amount of interest rate derivative financial instruments is $13.6 billion. The derivative financial instruments hedge U.S. dollar and euro fixed-rate debt.

Information about gains/(losses) incurred to hedge or offset foreign exchange or interest rate risk is as follows:

	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, 2011			July 4, 2010			July 3, 2011			July 4, 2010			July 3, 2011		July 4, 2010
Three Months Ended:
Derivative Financial Instruments in Fair Value Hedge Relationships(b)
Interest rate swaps	$	––		$	1		$	––		$	––		$	––	$	––
Foreign currency swaps		––			1			––			––			––		––

Derivative Financial Instruments in Cash Flow Hedge Relationships
Foreign currency swaps	$	––		$	––		$	227		$	(1,219	)	$	224	$	(627	)
Foreign currency forward-exchange contracts		––			––			1			(1	)		––		1

Derivative Financial Instruments in Net Investment Hedge Relationships
Foreign currency swaps	$	14		$	(1	)	$	(991	)	$	(50	)	$	––	$	––

Derivative Financial Instruments Not Designated as Hedges
Foreign currency swaps	$	13		$	(4	)	$	––		$	––		$	––	$	––
Foreign currency forward-exchange contracts		(158	)		(473	)		––			––			––		––

Non-Derivative Financial Instruments in Net Investment Hedge Relationships
Foreign currency short-term borrowings	$	––		$	––		$	897		$	(130	)	$	––	$	––
Foreign currency long-term debt		––			––			(34	)		(51	)		––		––
Total	$	(131	)	$	(476	)	$	100		$	(1,451	)	$	224	$	(626	)

Six Months Ended:
Derivative Financial Instruments in Fair Value Hedge Relationships(b)
Interest rate swaps	$	––		$	1		$	––		$	––		$	––	$	––
Foreign currency swaps		––			––			––			––			––		––

Derivative Financial Instruments in Cash Flow Hedge Relationships
Foreign currency swaps	$	––		$	––		$	531		$	(1,657	)	$	730	$	(1,255	)
Foreign currency forward-exchange contracts		––			––			3			(1	)		4		2

Derivative Financial Instruments in Net Investment Hedge Relationships
Foreign currency swaps	$	15		$	(1	)	$	(958	)	$	(40	)	$	––	$	––

Derivative Financial Instruments Not Designated as Hedges
Foreign currency swaps	$	43		$	––		$	––		$	––		$	––	$	––
Foreign currency forward-exchange contracts		(317	)		(1,363	)		––			––			––		––

Non-Derivative Financial Instruments in Net Investment Hedge Relationships
Foreign currency short-term borrowings	$	––		$	––		$	940		$	(99	)	$	––	$	––
Foreign currency long-term debt		––			––			(6	)		(34	)		––		––

Total	$	(259	)	$	(1,363	)	$	510		$	(1,831	)	$	734	$	(1,253	)

(a)	OID = Other (income)/deductions—net, included in the income statement account, Other deductions—net. OCI = Other comprehensive income/(loss), included in the balance sheet account Accumulated other comprehensive loss.

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

(c)	There was no significant ineffectiveness in the second quarter and first six months of 2011 or 2010.

(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)––Net unrealized (losses)/gains 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)––Currency translation adjustment and other.

For information about the fair value of our derivative financial instruments, and the impact on our Condensed Consolidated Balance Sheets, see Note 9A. Financial Instruments: Selected Financial Assets and Liabilities. 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. The aggregate fair value of these derivative instruments that are in a liability position is $362 million, for which we have posted collateral of $265 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 July 3, 2011, we would have been required to post an additional $106 million of collateral to our counterparties. The collateral advanced receivables are reported in Cash and cash equivalents.

E. 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, 2011, we had $3.5 billion due from a well-diversified, highly rated group (S&P ratings of primarily A+ or better) of bank counterparties around the world. See Note 9B. Financial Instruments: Investments in Debt Securities for a distribution of our investments.

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 July 3, 2011, we received cash collateral of $717 million against various counterparties. The collateral primarily supports the approximate fair value of our derivative contracts. The collateral received obligations are reported in Short-term borrowings, including current portion of long-term debt.