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Management’s Discussion and Analysis
GOLDMAN SACHS 2003 ANNUAL REPORT 39
principal investments – In valuing our corporate and real estate principal investments, we separate our portfolio into
investments in private companies and investments in public companies, including our investment in the convertible pre-
ferred stock of SMFG. The following table sets forth the carrying value of our principal investments portfolio:
PRINCIPAL INVESTMENTS
AS OF NOVEMBER
2003 2002
(IN MILLIONS) CORPORATE REAL ESTATE TOTAL CORPORATE REAL ESTATE TOTAL
Private $1,054 $757 $1,811 $ 881 $736 $1,617
Public 219 42 261 154 8 162
SMFG convertible preferred stock(1) 1,683 — 1,683 ———
Total $2,956 $799 $3,755(2) $1,035 $744 $1,779
(1) The fair value of our Japanese yen-denominated investment in SMFG convertible preferred stock includes the effect of foreign exchange revalu-
ation. We hedge our economic exposure to exchange rate movements on our investment in SMFG by borrowing Japanese yen. Foreign exchange
revaluation on the investment and the related borrowing are generally equal and offsetting. For example, if the Japanese yen appreciates against
the U.S. dollar, the U.S. dollar carrying value of our SMFG investment will increase and the U.S. dollar value of the related borrowing will also
increase by an equal and offsetting amount.
(2) Excludes assets of $1.07 billion in employee-owned merchant banking funds that were consolidated in 2003.
Our private principal investments, by their nature, have
little to no price transparency. Such investments are ini-
tially carried at cost as an approximation of fair value.
Adjustments to carrying value are made if there are third-
party transactions evidencing a change in value.
Downward adjustments are also made, in the absence of
third-party transactions, if we determine that the expected
realizable value of the investment is less than the carrying
value. In reaching that determination, we consider many
factors including, but not limited to, the operating cash
flows and financial performance of the companies or
properties relative to budgets or projections, trends within
sectors and/or regions, underlying business models,
expected exit timing and strategy, and any specific rights or
terms associated with the investment, such as conversion
features and liquidation preferences.
Our public principal investments, which tend to be large,
concentrated holdings that resulted from initial public
offerings or other corporate transactions, are valued
using quoted market prices discounted for restrictions on
sale. If liquidating a position is reasonably expected to
affect market prices, valuations are adjusted accordingly
based on predetermined written policies.
Our investment in the convertible preferred stock of
SMFG is carried at fair value, which is derived from a
model that incorporates SMFG’s common stock price and
credit spreads, the impact of transfer restrictions on our
investment and the downside protection on the con-
version strike price. The fair value of our investment is
particularly sensitive to movements in the SMFG common
stock price. Since February 7, 2003, the date of our invest-
ment in the convertible preferred stock of SMFG, the fair
value of our investment increased 23% (expressed in
Japanese yen), primarily due to a 66% increase in the
SMFG common stock price. As a result of transfer restric-
tions and the downside protection on the conversion
strike price, the relationship between changes in the fair
value of our investment and changes in SMFG’s common
stock price is nonlinear.
controls over valuation of financial instruments –
Proper controls, independent of the trading and principal
investing functions, are fundamental to ensuring that our
financial instruments are appropriately and consistently
valued and that fair value measurements are reliable. This
is particularly important in valuing instruments with
lower levels of price transparency.
We employ an oversight structure that includes appropri-
ate segregation of duties. Senior management, indepen-
dent of the trading functions, is responsible for the
oversight of control and valuation policies and proce-
dures and reporting the results of such work to the Audit
Committee. We seek to maintain the necessary resources,
with the appropriate experience and training, to ensure
that control and independent price verification func-
tions are performed to the highest standards. In addi-
tion, we employ procedures for the approval of new
transaction types and markets, independent price verifi-
cation, review of daily profit and loss, and review of val-
uation models by personnel with appropriate technical
knowledge of relevant markets and products. For a fur-
ther discussion of how we manage the risks inherent in
our trading and principal investing businesses, see
“— Risk Management.”