Goldman Sachs 2003 Annual Report Download - page 39

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Management’s Discussion and Analysis
GOLDMAN SACHS 2003 ANNUAL REPORT 37
Cash trading instruments we own (long positions) are
marked to bid prices and instruments we have sold but
not yet purchased (short positions) are marked to offer
prices. If liquidating a position is reasonably expected to
affect its prevailing market price, our valuation is adjusted
The fair values of our exchange-traded derivatives are
generally determined from quoted market prices. OTC
derivatives are valued using valuation models. We use a
variety of valuation models including the present value of
known or estimated cash flows, option-pricing models
and option-adjusted spread models. The valuation mod-
els that we use to derive the fair values of our OTC deriv-
atives require inputs including contractual terms, market
prices, yield curves, credit curves, measures of volatility,
prepayment rates and correlations of such inputs.
At the inception of an OTC derivative contract (day one),
we value the contract at the model value if we can verify
all of the significant model inputs to observable market
data and verify the model value to market transactions.
When appropriate, valuations are adjusted to take
account of various factors such as liquidity, bid/offer and
credit considerations. These adjustments are generally
based on market evidence or predetermined policies. In
certain circumstances, such as for highly illiquid posi-
tions, management’s estimates are used to determine
these adjustments.
Where we cannot verify all of the significant model inputs
to observable market data and verify the model value to
market transactions, we value the contract at the trans-
action price at inception and, consequently, record no day
one gain or loss in accordance with Emerging Issues Task
Force (EITF) Issue No. 02-3, “Issues Involved in
Accounting for Derivative Contracts Held for Trading
Purposes and Contracts Involved in Energy Trading and
Risk Management Activities.” For a further discussion of
EITF Issue No. 02-3, see Note 2 to the consolidated
financial statements.
Following day one, we adjust the inputs to our valuation
models only to the extent that changes in such inputs can
be verified by similar market transactions, third-party pric-
ing services and/or broker quotes or can be derived from
other substantive evidence such as empirical market data.
In circumstances where we cannot verify the model value
to market transactions, it is possible that a different valua-
tion model could produce a materially different estimate of
fair value.
generally based on market evidence or predetermined
policies. In certain circumstances, such as for highly illiq-
uid positions, management’s estimates are used to deter-
mine this adjustment.
derivative contracts – Derivative contracts consist of exchange-traded and over-the-counter (OTC) derivatives. The
following table sets forth the fair value of our exchange-traded and OTC derivative assets and liabilities:
DERIVATIVE ASSETS AND LIABILITIES
AS OF NOVEMBER
2003 2002
(IN MILLIONS) ASSETS LIABILITIES ASSETS LIABILITIES
Exchange-traded derivatives $ 5,182 $ 6,339 $ 8,911 $ 8,630
OTC derivatives 40,551 35,547 33,294 30,291
Total(1) $45,733 $41,886 $42,205 $38,921
(1) The fair values of our derivative assets and liabilities include cash we have paid and received (for example, option premiums or cash paid or
received pursuant to credit support agreements) and may change significantly from period to period based on, among other factors, changes in
our trading positions and market movements.