11.    Financial Instruments

The Company uses derivative financial instruments as part of its overall strategy to manage its exposure to market risks primarily associated with fluctuations in foreign currency and interest rates. The Company does not use derivatives for trading or speculative purposes.

As of December 31, 2013, the Company had a net asset position of $10 million related to derivative instruments associated with its euro denominated and floating rate debt, its foreign currency denominated receivables and payables, and forecasted earnings of its foreign subsidiaries.

Interest Rate Risk

The primary interest rate exposure as of December 31, 2013 was to interest rate fluctuations in the United States, specifically the impact of USLIBOR interest rates on dollar denominated variable rate borrowings. During 2013 and in previous years, the Company was also exposed to interest rate exposure due to the impact of EURIBOR interest rates on its euro denominated variable rate debt. In previous years and during part of 2013, the Company used interest rate swap derivative contracts, to economically hedge the exposure to fluctuations in the interest rate risk by creating an appropriate mix of fixed and floating rate debt. These derivative instruments were not considered as accounting hedges and changes in the fair value of these derivatives were recorded in consolidated statement of operations when they occurred. In 2011 and in previous periods the Company also used cross currency swaps as the derivative financial instruments in these hedging strategies. The Company did not designate these interest rate and cross currency swaps as accounting hedges. Fluctuations in the value of these contracts were recorded within the Company’s consolidated statements of operations, which were largely offset by the impact of the changes in the value of the underlying risk they were intended to economically hedge.

In August 2013, the Company’s interest rate swap derivative contracts expired and it entered into interest rate cap derivative contracts to cap the maximum USLIBOR rate to which the Company may be exposed at 1.5%. The purpose of these contracts is to hedge the risk of an increase in interest costs on the Company’s floating rate debt due to an increase in USLIBOR rates. The Company has designated these interest rate cap derivative contracts as accounting cash flow hedges and records the effective portion of changes in fair value of these derivative contracts as a component of other comprehensive income (loss) with the ineffective portion recognized in earnings in the consolidated statements of operations.

Foreign Currency Risk

The Company uses foreign currency derivative contracts, including forward contracts and currency options, to manage its exposure to changes in foreign currency exchange rates associated with its euro denominated debt, its foreign currency denominated receivables and payables, and forecasted earnings of its foreign subsidiaries (primarily to manage its foreign currency exposure to British pound, Euro and Australian dollar). The Company does not designate these foreign currency derivative contracts as accounting hedges. Fluctuations in the value of these foreign currency derivative contracts are recorded within the Company’s consolidated statements of operations, which partially offset the impact of the changes in the value of the euro denominated debt, foreign currency denominated receivables and payables and forecasted earnings they are intended to economically hedge.

With the comprehensive refinancing during the year 2013 and the repayment of euro denominated debt, the Company has lower foreign exchange risk related to its euro denominated debt compared to prior years.

Credit Risk and Exposure

The Company is exposed to counterparty credit risk in the event of non-performance by counterparties to various agreements and sales transactions. The Company manages such risk by evaluating the financial position and creditworthiness of such counterparties. The Company mitigates counterparty credit risk associated with its derivative contracts by monitoring the amounts at risk with each counterparty to such contracts, periodically evaluating counterparty creditworthiness and financial position, and where possible, dispersing its risk among multiple counterparties. As of December 31, 2013, there were no significant concentrations of counterparty credit risk with any individual counterparty or group of counterparties for derivative contracts.

Fair Value Disclosures for Derivative Instruments

The Company’s financial assets and liabilities recorded at fair value consist primarily of derivative instruments. These amounts have been categorized based upon a fair value hierarchy and were all categorized as Level 2 — Significant Other Observable Inputs as of December 31, 2013 and as Level 3 — Significant Unobservable Inputs as of December 31, 2012. See Note 2 — Summary of Significant Accounting Policies, for a discussion of the Company’s policies regarding this hierarchy.

The fair value of interest rate cap and interest rate swap derivative instruments is determined using pricing models based on discounted cash flows that use inputs from actively quoted markets for similar instruments. The fair value of foreign currency forward contracts is determined by comparing the contract rate to a published forward price of the underlying currency, which is based on market rates for comparable transactions. The fair value of foreign currency option contracts is based on valuations provided by the financial institutions based on market observable data. These fair values are then adjusted for the Company’s own credit risk or counterparty credit risk, as appropriate. This adjustment is calculated based on the default probability of the banking counterparty or the Company and is obtained from active credit default swap markets.

The Company reviews the fair value hierarchy classification for financial assets and liabilities at the end of each quarter. Changes in significant unobservable valuation inputs may trigger reclassification of financial assets and liabilities between fair value hierarchy levels. As of December 31, 2013, credit risk fair value adjustments constituted less than 15% of the unadjusted fair value of derivative instruments. In instances where Credit Valuation Adjustment (“CVA”) comprises 15% or more of the unadjusted fair value of the derivative instrument for two consecutive quarters the Company’s policy is to categorize the derivative as Level 3 of the fair value hierarchy. As the CVA applied to arrive at the fair value of derivatives is less than 15% of the unadjusted fair value of derivative instruments for two consecutive quarters, the Company has categorized derivative fair valuations at Level 2 of the fair value hierarchy. Transfers into and out of Level 3 of the fair value hierarchy are recognized at the end of each quarter when such categorization takes place.

Presented below is a summary of the gross fair value of the Company’s derivative contracts recorded on the consolidated balance sheets at fair value.

 

				Fair Value Asset										Fair Valve (Liability)
(in $ millions)		Balance Sheet Location		December 31, 2013				December 31, 2012				Balance Sheet Location		December 31, 2013				December 31, 2012
Derivatives designated as hedging instruments:
Interest rate caps		Other non-current assets			8				—			Accrued expenses and other current liabilities			—				—
Derivatives not designated as hedging instruments:
Interest rate swaps		Other current assets			—				—			Accrued expenses and other current liabilities			—				(3	)
Foreign currency contracts		Other current assets			3				10			Accrued expenses and other current liabilities			(1	)			(1	)
Foreign currency contracts		Other non-current assets			—				5			Other non-current liabilities			—				—
Total fair value of derivative assets (liabilities)					11				15						(1	)			(4	)

 

As of December 31, 2013, the notional amounts of the above derivative contracts were as follows:

 

(in $ millions)		Amount
Interest rate caps			2,330
Foreign currency options			219
Foreign currency forwards			158

The interest rate cap derivative contracts cover transactions for periods that do not exceed three years. All other contracts cover transactions for periods that do not exceed one year.

The following table provides a reconciliation of the movement in the net carrying amount of derivative financial instruments during the year ended December 31, 2013.

 

(in $ millions)		Amount
Net derivative asset as of January 1, 2013			11
Loss for the period included in net loss			(7	)
Loss for the period included in other comprehensive income (loss)			(4	)
Premium paid for interest rate cap derivative contracts			12
Proceeds from settlement of foreign currency derivative contracts hedging debt instruments, net			(3	)
Settlement of foreign currency derivative contracts and interest rate swaps, net			4
Termination of foreign currency derivative contracts (settlement pending)			(3	)
Net derivative asset as of December 31, 2013			10

The Company paid $7 million in relation to certain foreign currency derivative contracts which were terminated in 2012 and included within accrued expenses and other current liabilities as at December 31, 2012. The Company paid $51 million and received $9 million in cash on settlement of foreign currency derivative contracts during the year ended December 31, 2012. The Company received $34 million in cash on settlement of foreign currency derivative contracts during the year ended December 31, 2011.

The significant unobservable inputs used to fair value the Company’s derivative financial instruments are probability of default of approximately 2%, and a recovery rate of 20%, which are applied to the Company’s credit default swap adjustments. A 10% change in the significant unobservable inputs will not have a material impact on the fair value of the derivative financial instruments as of December 31, 2013.

 

The table below presents the impact that changes in fair values of derivatives designated as hedges had on accumulated other comprehensive income (loss) and income (loss) during the year and the impact derivatives not designated as hedges had on income (loss) during that year.

 

		Amount of Gain (Loss) Recognized in Other Comprehensive Income (Loss)														Amount of Gain (Loss) Recorded into Income (Loss)
		Year Ended December 31,												Location of Gain (Loss) Recorded in Income (Loss)		Year Ended December 31,
(in $ millions)		2013				2012				2011						2013				2012				2011
Derivatives designated as hedging instruments:
Interest rate caps			(4	)			—				—			Interest expense, net			—				—				—
Interest rate swaps			—				—				—			Interest expense, net			—				—				(9	)
Derivatives not designated as hedging instruments:
Interest rate swaps														Interest expense, net			(3	)			(4	)			(4	)
Foreign exchange impact of cross currency swaps														Selling, general and administrative			—				—				14
Foreign currency contracts														Selling, general and administrative			(4	)			—				(16	)
																	(7	)			(4	)			(15	)

The table above includes (i) unrealized losses on interest rate caps held as of December 31, 2013, amounting to $4 million for the year ended December 31, 2013, and (ii) unrealized loss on foreign currency derivative contracts of $0 for the year ended December 31, 2013.

During 2010, the Company de-designated as hedges certain of its derivative contracts. The total loss in relation to these contracts of $9 million as of December 31, 2010 and included within accumulated other comprehensive income (loss) was recorded in income (loss) in the Company’s consolidated statement of operations over the year through December 31, 2011, in line with the hedged transactions affecting earnings.

Fair Value Disclosures for All Financial Instruments

The carrying amounts of cash and cash equivalents, accounts receivable, other current assets, accounts payable and accrued expenses and other current liabilities approximate fair value due to the short-term maturities of these assets and liabilities. The carrying value of cash held as collateral approximates to its fair value.

The fair values of the Company’s other financial instruments are as follows:

 

						December 31, 2013								December 31, 2012
(in $ millions)		Fair Value Hierarchy				Carrying Amount				Fair Value				Carrying Amount				Fair Value
Asset (liability)
Investment in Orbitz Worldwide			Level 1				19				349				—				133
Derivative assets			Level 2				11				11				15				15
Derivative liabilities			Level 2				(1	)			(1	)			(4	)			(4	)
Total debt			Level 2				(3,573	)			(3,693	)			(3,430	)			(2,899	)

The fair value of the Company’s investment in Orbitz Worldwide, which is categorized within Level 1 of the fair value hierarchy, has been determined based on quoted prices in active markets.

 

The fair value of the Company’s total debt has been determined by calculating the fair value of term loans, Senior Notes and Senior Subordinated Notes based on quoted prices obtained from independent brokers for identical debt instruments when traded as an asset and is categorized within Level 2 of the fair value hierarchy.