Barclays 2014 Annual Report Download - page 294

292 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
Net Asset Value
Net asset value represents the total value of a fund’s assets and liabilities.
In general, a significant increase in net asset value in isolation will result in a movement in fair value that is favourable for a fund.
Volatility
Volatility is a key input in the valuation of derivative products containing optionality. Volatility is a measure of the variability or uncertainty in
returns for a given derivative underlying. It represents an estimate of how much a particular underlying instrument, parameter or index will change
in value over time. In general, volatilities will be implied from observed option prices. For unobservable options the implied volatility may reflect
additional assumptions about the nature of the underlying risk, as well as reflecting the given strike/maturity profile of a specific option contract.
In general a significant increase in volatility in isolation will result in a movement in fair value that is favourable for the holder of a simple option,
but the sensitivity is dependent on the specific terms of the instrument.
There may be inter-relationships between unobservable volatilities and other unobservable inputs that can be implied from observation (e.g. when
equity prices fall, implied equity volatilities generally rise) but these are specific to individual markets and may vary over time.
Yield
The rate used to discount projected cash flows in a discounted future cash flow analysis.
In general, a significant increase in yield in isolation will result in a movement in fair value that is unfavourable for the holder of a cash instrument.
Fair value adjustments
Key balance sheet valuation adjustments are quantified below:
2014
£m
2013
£m
Bid-offer valuation adjustments (396) (406)
Other exit adjustments (169) (208)
Uncollateralised derivative funding (100) (67)
Derivative credit valuation adjustments:
– Monolines (24) (62)
– Other derivative credit valuation adjustments (394) (322)
Derivative debit valuation adjustments 177 310
Bid-offer valuation adjustments
The Group uses mid-market pricing where it is a market maker and has the ability to transact at, or better than, mid price (which is the case for
certain equity, bond and vanilla derivative markets). For other financial assets and liabilities, bid-offer adjustments are recorded to reflect the price
for the expected close out strategy. The methodology for determining the bid-offer adjustment for a derivative portfolio involves calculating the
net risk exposure by offsetting long and short positions by strike and term in accordance with the risk management and hedging strategy.
Bid-offer levels are derived from market sources, such as broker data.
Other exit adjustments
Market data input for exotic derivatives may not have a directly observable bid-offer spread. In such instances, an exit adjustment is applied as a
proxy for the bid-offer adjustment. An example of this is correlation risk where an adjustment is applied to reflect the possible range of values that
market participants apply. The exit adjustment may be determined by calibrating to derivative prices, or by scenario analysis or historical analysis.
The other exit adjustments have reduced by £39m to £169m respectively as a result of movements in market bid-offer spreads.
Discounting approaches for derivative instruments
Collateralised
In line with market practice, the methodology for discounting collateralised derivatives takes into account the nature and currency of the collateral
that can be posted within the relevant Credit Support Annex (CSA). This CSA-aware discounting approach recognises the ‘cheapest to deliver’
option that reflects the ability of the party posting collateral to change the currency of the collateral.
Uncollateralised
A fair value adjustment of £100m is applied to account for the impact of incorporating the cost of funding into the valuation of uncollateralised
derivative portfolios and collateralised derivatives where the terms of the agreement do not allow the rehypothecation of collateral received. This
adjustment is referred to as the ‘Funding Fair Value Adjustment’ (FFVA). FFVA has increased by £33m to £100m mainly as a result of interest rates
decreasing, causing uncollateralised exposures to increase.
FFVA is determined by calculating the net expected exposure at a counterparty level and applying a funding rate to these exposures that reflects
the market cost of funding. Barclays’ internal Treasury lending rates are used as an input to the calculation. The approach takes into account the
probability of default of each counterparty, as well as any mandatory break clauses.
The FFVA incorporates a scaling factor which is an estimate of the extent to which the cost of funding is incorporated into observed traded levels.
On calibrating the scaling factor, it is with the assumption that Credit Valuation Adjustments (CVA) and Debit Valuation Adjustments (DVA) are
retained as valuation components incorporated into such levels. The effect of incorporating this scaling factor at 31 December 2014 was to reduce
the FFVA by £300m (2013: £200m).