Barclays 2009 Annual Report Download - page 300

298 Barclays PLC Annual Report 2009 www.barclays.com/annualreport09
Notes to the accounts
For the year ended 31st December 2009
continued
50 Fair value of financial instruments continued
Other credit products
These products are linked to the credit spread of a referenced entity, index or basket of referenced entities. This category includes synthetic CDOs; single name
and index CDS and Nth to default basket swaps. Within this population, valuation inputs are unobservable for certain synthetic CDOs and CDS with illiquid
reference assets.
Synthetic CDOs are valued using a model that calculates fair value based on observable and unobservable parameters including credit spreads, recovery
rates, correlations and interest rates and is calibrated daily. For index and bespoke synthetic CDOs with unobservable inputs, correlation is set with reference
to index tranche market.
CDS with illiquid reference assets are valued using an industry standard ‘hazard-type’ model that calculates fair value of the credit protection using interest
rates, credit spreads and recovery rates of the underlying issuers. Interest rates are observable and sourced from liquid interest rate instruments. Credit
spreads are unobservable and are determined with reference to recent transactions or bond spreads from observable issuances of the same issuer or other
similar obligors as a proxy.
Derivative exposure to Monoline insurers
These products comprise securities, principally CLOs, on which default protection has been purchased. Credit spreads of the counterparty providing
protection are unobservable.
The derivative positions are valued with reference to the price of the underlying security. As the security and derivative are hedged, the net present value of
the derivative increases as the net present value of the security decreases. The derivative valuation is then adjusted to reflect the credit quality of the
counterparty.
Non-asset backed debt instruments
These are government bonds; US agency bonds; corporate bonds; commercial paper; certificates of deposit; convertible bonds; notes and other non-asset
backed bonds. Within this population, valuation inputs are unobservable for certain convertible bonds, corporate bonds and issued notes.
Convertible bonds are valued using prices observed through broker sources, market data services and trading activity. Prices are validated against liquid
external sources. Where liquid external sources are not available, fair value is determined using a spread to the equity conversion value or the value of the
bond without the additional equity conversion. The spread level is determined with reference to similar proxy assets. Positions are valued on a daily basis.
Corporate bonds are valued on a price basis or using spreads over risk free interest rate curves built from liquid instruments. Where unobservable, bond
spreads are determined by reference to either issuances or alternatively CDS spreads of the same issuer are used as proxy inputs to obtain discounted cash
flows and accordingly the value of the bond. In the absence of observable bond or CDS spreads of the respective issuer, similar reference assets or sector
averages are applied as a proxy.
Fixed and floating rate notes issued, in certain emerging markets, are valued using models that discount expected future cash flows. These proprietary
models calculate fair value based on observable interest rates and unobservable funding or credit spreads. The interest rates are derived from broker and
bank notes rates. Funding spreads up to five years are sourced from negotiable commercial deposit rates in the market as a proxy. Funding spreads greater
than five years are determined by applying linear extrapolation.
Equity products
This category includes listed equities; exchange traded derivatives; OTC equity derivatives; preference shares and contracts for difference. Within this
population, valuation inputs for certain OTC equity derivatives are unobservable.
OTC equity derivatives valuation are determined using industry standard models. The models calculate fair value based on input parameters such as stock
prices, dividends, volatilities, interest rates, equity repo curves and, for multi-asset products, correlations. In general, input parameters are deemed
observable up to liquid maturities which are determined separately for each parameter and underlying instrument. Unobservable model inputs are set by
referencing liquid market instruments and applying extrapolation techniques to match the risk profile of the trading portfolio. These are validated against
consensus market data services for the same or similar underlying instrument. Models are calibrated daily based on liquid market instrument prices.
Private equity
Private equity investments are valued in accordance with the ‘International Private Equity and Venture Capital Valuation Guidelines’. This requires the use
of a number of individual pricing benchmarks such as the prices of recent transactions in the same or similar instruments, discounted cash flow analysis,
and comparison with the earnings multiples of listed comparative companies. Unobservable inputs include earnings estimates, multiples of comparative
companies, marketability discounts and discount rates. Model inputs are based on market conditions at the reporting date. The valuation of unquoted
equity instruments is subjective by nature. However, the relevant methodologies are commonly applied by other market participants and have been
consistently applied over time. Full valuations are performed bi-annually, with the portfolio reviewed on a monthly basis for material events that might
impact upon fair value.