CAPITAL POWER CORPORATION Notes to the Consolidated Financial Statements (Tabular amounts in millions of Canadian dollars, except share and per share amounts) 14. Derivative financial instruments and hedge accounting, continued: Fair values of derivative instruments are determined, when possible, using exchange or over-the-counter price quotations by reference to quoted bid, ask or closing market prices as appropriate, in the most advantageous active market for that instrument. The extent to which fair values of derivative instruments are based on observable market data is determined by the extent to which the market for the underlying commodity is judged to be active. When traded markets are not considered to be sufficiently active or do not exist, the Company uses appropriate valuation and price modeling techniques commonly used by market participants to estimate fair value. The Company may also rely on price forecasts prepared by third party market experts to estimate fair value when there are limited observable prices available. Fair values determined using valuation models require the use of assumptions concerning the amounts and timing of future cash flows. Fair value amounts reflect management’s best estimates and maximize, when available, the use of external readily observable market data including future prices, interest rate yield curves, foreign exchange rates, quoted Canadian dollar swap rates, counterparty credit risk, the Company’s own credit risk and volatility. When a valuation technique utilizes unobservable market data, no inception gains or losses are recognized, until market quotes or data becomes observable. It is possible that the assumptions used in establishing fair value amounts will differ from future outcomes and the impact of such variations could be material. Unrealized and realized pre-tax gains and losses on derivative financial instruments recognized in other comprehensive income and net income were: Realized gains and losses relate only to derivative financial instruments. The following items are included in the Company’s statements of income for the years ended December 31, 2012 and 2011. If hedge accounting requirements are not met, unrealized and realized gains and losses on financial energy derivatives are recorded in revenues or energy purchases and fuel as appropriate. If hedge accounting requirements are met, realized gains and losses on financial energy derivatives are recorded in revenues or energy purchases and fuel, as appropriate, while unrealized gains and losses are recorded in other comprehensive income. Unrealized and realized gains and losses on financial foreign exchange derivatives are recorded in revenues or foreign exchange gains and losses while such gains and losses on financial interest rate derivatives are recorded in finance expense. The Company has elected to apply hedge accounting on certain derivatives it uses to manage commodity price risk relating to electricity and natural gas prices. For the year ended December 31, 2012, the changes in the fair value of the ineffective portion of hedging derivatives required to be recognized in the statement of income was nil (year ended December 31, 2011 - losses of $2 million). 101 Year ended December 31, 2012 Year ended December 31, 2011 Unrealized gains (losses) Realized gains (losses) Unrealized gains (losses) Realized gains (losses) Energy cash flow hedges $ 52 $ 14 $ (62) $ (53) Energy non-hedges (11) 24 (41) (8) Foreign exchange non-hedges - - (10) 3 Interest rate non-hedges 8 (7) (2) (12) 2012 2011 Revenues $ 48 $ (142) Energy purchases and fuel (21) 39 Foreign exchange losses - (6) Finance expense 1 (14)