Barclays 2010 Annual Report Download - page 259

41 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 CDS with illiquid reference assets
and certain synthetic CDOs.
A market standard model is used in the valuation of CDS whereby the credit curve is the significant input in the overall valuation. Credit spreads are
observed directly from broker data, third party vendors or priced to proxies. Where credit spreads are unobservable, they are determined with reference
to recent transactions or bond spreads from observable issuances of the same issuer or other similar entities as a proxy.
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.
Derivative exposure to Monoline insurers
These products are derivatives through which default protection has been purchased on securities, primarily CLOs.
The credit spreads of the counterparty providing protection are unobservable at the required maturity. 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.
Exchange traded government bonds are classified as Level 1. Less liquid, government bonds, US agency bonds, corporate bonds, commercial paper
and certificates of deposit are valued using observable market prices which are sourced from broker quotes, inter-dealer prices or other reliable pricing
services. Where there are not observable market prices, fair value is determined by reference to either issuances or CDS spreads of the same issuer as
proxy inputs to obtain discounted cash flows to value the bond. In the absence of observable bond or CDS spreads for the respective issuer, similar
reference assets or sector averages are applied as a proxy.
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.
Most fixed and floating rate notes issued are valued using models that discount expected future cash flows. These models calculate fair value based
on observable interest rates and funding or credit spreads. The interest rates are derived from broker and bank notes rates. In certain emerging markets,
funding spreads may be unobservable. 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 extrapolation techniques.
Equity Linked Notes valuations 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 observable,
with unobservable inputs having an insignificant impact on the valuation.
The valuation for fund linked notes is consistent with the valuation of the underlying (see the ‘Funds and fund–linked products’ section below).
Equity products
This category includes listed equities, exchange traded equity derivatives, OTC equity derivatives, preference shares and contracts for difference.
OTC equity derivatives valuations 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 reference to 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.
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 cashflow 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.
Barclays PLC Annual Report 2010 www.barclays.com/annualreport10 257
Strategy Performance Risk management and governance Shareholder informationFinancial statementsAbout Barclays