Barclays 2014 Annual Report Download - page 288

286 I Barclays PLC Annual Report 2014 barclays.com/annualreport
Notes to the financial statements
Assets and liabilities held at fair value
18 Fair value of financial instruments continued
Interest rate derivatives
Description: These are derivatives linked to interest rates or inflation indices. This category includes futures, interest rate and inflation swaps,
swaptions, caps, floors, inflation options, balance guaranteed swaps and other exotic interest rate derivatives.
Valuation: Interest rate derivative cash flows are valued using interest rate yield curves whereby observable market data is used to construct the
term structure of forward rates. This is then used to project and discount future cash flows based on the parameters of the trade. Instruments with
optionality are valued using volatilities implied from market observable inputs. Exotic interest rate derivatives are valued using industry standard
and bespoke models based on observable and unobservable market parameter inputs. Input parameters include interest rates, volatilities,
correlations and others as appropriate. Where unobservable, a parameter will be set with reference to an observable proxy. Inflation forward curves
and interest rate yield curves are extrapolated beyond observable tenors.
Balance guaranteed swaps are valued using cash flow models that calculate fair value based on loss projections, prepayment, recovery and
discount rates. These parameters are determined by reference to underlying asset performance, independent research, ABX indices, broker quotes,
observable trades on similar securities, and third party pricing sources. Prepayment is projected based on observing historic prepayment rates.
Observability: In general, input parameters are deemed observable up to liquid maturities which are determined separately for each parameter and
underlying. Certain correlation, convexity, long dated forwards and volatility exposures are unobservable beyond liquid maturities. Unobservable
model inputs are set by referencing liquid market instruments and applying extrapolation techniques to match the appropriate risk profile.
Level 3 sensitivity: Sensitivity relating to unobservable valuation inputs is based on the dispersion of consensus data services where available,
otherwise stress scenarios or historic data are used.
Foreign exchange derivatives
Description: These are derivatives linked to the foreign exchange (FX) market. This category includes FX forward contracts, FX swaps and FX
options. The vast majority are traded as OTC derivatives.
Valuation: Exotic and non-exotic derivatives are valued using industry standard and bespoke models. Input parameters include FX rates, interest
rates, FX volatilities, interest rate volatilities, FX interest rate correlations and others as appropriate. Unobservable model inputs are set by
referencing liquid market instruments and applying extrapolation techniques to match the appropriate risk profile.
Observability: Certain correlations, long dated forwards and volatilities are unobservable beyond liquid maturities.
Level 3 sensitivity: Sensitivity relating to unobservable valuation inputs is primarily based on the dispersion of consensus data services.
Credit derivatives
Description: These are derivatives linked to the credit spread of a referenced entity, index or basket of referenced entities or a pool of referenced
assets via securitisation. This category includes single name and index Credit Default Swaps (CDS), asset backed CDS, synthetic Collateralised
Debt Obligations (CDOs), and Nth-to-default basket swaps.
Valuation: CDS are valued using a market standard model that incorporates the credit curve as its principal input. 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 proxied from bond spreads on observable trades of the same issuer or other similar entities. Synthetic CDOs are valued
using a model that calculates fair value based on credit spreads, recovery rates, correlations and interest rates, and is calibrated to the index
tranche market.
Observability: CDS contracts referencing entities that are not actively traded are considered unobservable. The correlation input to synthetic CDO
valuation is considered unobservable as it is proxied from the observable index tranche market. Where an asset backed credit derivative does not
have an observable market price and the valuation is determined using a model, an instrument is considered unobservable.
Level 3 sensitivity: The sensitivity of valuations of the illiquid CDS portfolio is determined by applying a shift to each spread curve. The shift is
based on the average range of pricing observed in the market for similar CDS.
Synthetic CDO sensitivity is calculated using correlation levels derived from the range of contributors to a consensus bespoke service.
Commodity derivatives
Description: These products are exchange traded and OTC derivatives based on underlying commodities such as metals, crude oil and refined
products, agricultural, power and natural gas.
Valuation: The valuations of commodity swaps and options are determined using models incorporating discounting of cash flows and other
industry standard modelling techniques. Valuation inputs include forward curves, volatilities implied from market observable inputs and
correlations. Unobservable inputs are set with reference to similar observable products or by applying extrapolation techniques from the
observable market.
Observability: Certain correlations, forward curves and volatilities for longer dated exposures are unobservable.
Level 3 sensitivity: Sensitivity is determined primarily by measuring historical variability over two years. Where historical data is unavailable or
uncertainty is due to volumetric risk, sensitivity is measured by applying appropriate stress scenarios or using proxy bid-offer spread levels.
Equity derivatives
Description: These are derivatives linked to equity indices and single names. This category includes exchange traded and OTC equity derivatives
including vanilla and exotic options.
Valuation: The valuations of OTC equity derivatives are determined using industry standard models. Input parameters include stock prices,
dividends, volatilities, interest rates, equity repo curves and, for multi-asset products, correlations. Unobservable model inputs are determined by
reference to liquid market instruments and applying extrapolation techniques to match the appropriate risk profile.