Barclays 2009 Annual Report Download - page 301

www.barclays.com/annualreport09 Barclays PLC Annual Report 2009 299
50 Fair value of financial instruments continued
Fund and fund-linked products
This category includes holdings in hedge funds; funds of funds; and fund derivatives. Fund derivatives are derivatives whose underlyings include mutual
funds, hedge funds, indices and multi-asset portfolios. They are valued using underlying fund prices, yield curves and other available market information.
In general fund holdings are valued based on the latest available valuation received from the fund administrator. Funds are deemed unobservable where the
fund is either suspended, in wind-down, has a redemption restriction that severely affects liquidity, or where the latest Net Asset Value (NAV) from the fund
administrators is more than three months old. In the case of illiquid fund holdings the valuation will take account of all available information in relation to the
underlying fund or collection of funds and may be adjusted relative to the performance of relevant index benchmarks. Prices are marked based on available
valuation data and any adjustments are reviewed on a monthly basis.
FX products
These products are derivatives linked to the foreign exchange market. This category includes Forward contracts, FX swaps and FX options.
Exotic derivatives are valued using industry standard and proprietary models. Fair value is based on input parameters that include FX rates, interest rates, FX
volatilities, interest rate volatilities, FX interest rate correlations and other model parameters. 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 on a monthly basis.
Interest rate products
These are products with a payoff linked to interest rates for example Libor (London interbank offer rate) or inflation rates and indices. This category includes
interest rate and inflation swaps; swaptions; caps; floors; inflation options; Bank of England base rate derivatives and other exotic interest rate derivatives.
Inflation structured and property index-linked products are valued using an industry standard model. The model calculates fair value based on observable
and unobservable parameters such as inflation index levels, volatilities and correlations sourced from trading information, broker data and historical analysis.
The assumptions and inputs applied reflect observable parameters such as yield curves, interpolation adjustments for the seasonal nature of inflation and
volatility surfaces. The most significant unobservable input is correlation between inflation indices. The suitability of the models employed is reviewed on an
annual basis.
Bank of England base rate derivatives are valued using standard discounted cash flows techniques. Bank of England forward base rates are used as inputs
into the valuation model. These forward base rates are constructed from the base rate yield curve set from market data up to five years. For maturities
greater than five years, spreads to observable proxies are applied. The base rate yield curve used is updated daily.
Commodity products
These products are exchange traded and OTC derivatives based on an underlying commodity such as metals, oil and oil related, power and natural gas.
Within this population, valuation inputs of certain commodity swaps and options are unobservable.
Valuation inputs of certain commodity swaps and options are determined using models incorporating discounting of cash flows, closed form Black models
and Monte-Carlo simulation. The models calculate fair value based on inputs such as forward curves, volatility surfaces and tenor correlation. Unobservable
inputs are set with reference to similar observable products or by applying extrapolation techniques from the observable market. As markets close at
different times, curves are constructed using a spread to the primary market benchmark to ensure that all curves are valued using the dominant market
base price.
The frequency and method used to calibrate the model is based on an assessment of observable option and swap prices.
Other
This category is primarily made up of fixed rate loans, which are valued using models that discount expected future cash flows. These models calculate
the fair value based on observable interest rates and unobservable funding or credit spreads. Unobservable funding or credit spreads are determined by
applying linear extrapolation of observable spreads.
Fair value adjustments
The main adjustments to model or system balances to arrive at a fair value are described below:
Bid-Offer valuation adjustments
Portfolios are valued to reflect the most advantageous market price to which Barclays has immediate access. For assets and liabilities where the firm is not a
market maker, mid prices are adjusted to bid and offer prices respectively. The bid-offer adjustment factors reflect the expected close out strategy and, for
derivatives, that they are managed on a portfolio basis. The methodology for determining the bid-offer adjustment for a derivative portfolio will generally
involve netting between long and short positions and the bucketing of risk by strike and term in accordance with hedging strategy. Bid-offer levels are
derived from market sources, such as broker data, and are reviewed periodically. For those assets and liabilities where the firm is a market maker (which is
the case for certain equity, bond and vanilla derivative markets), since the bid-offer spread does not represent a transaction cost, mid prices are used.