Goldman Sachs 2007 Annual Report Download - page 47

Management’s Discussion and Analysis
■ PUBLIC PRINCIPAL INVESTMENTS. Our public principal
investments held within the Principal Investments component
of our Trading and Principal Investments segment tend to be
large, concentrated holdings resulting from initial public
offerings or other corporate transactions, and are valued
based on quoted market prices. For positions that are not
traded in active markets or are subject to transfer restrictions,
valuations are adjusted to reflect illiquidity and/or non-
transferability, and such adjustments are generally based on
available market evidence. In the absence of such evidence,
management’s best estimate is used.
Our most significant public principal investment is our
investment in the ordinary shares of ICBC. Our investment
in ICBC is valued using the quoted market prices adjusted
for transfer restrictions. The ordinary shares acquired from
ICBC are subject to transfer restrictions that, among other
things, prohibit any sale, disposition or other transfer until
April 28, 2009. From April 28, 2009 to October 20, 2009,
we may transfer up to 50% of the aggregate ordinary shares
of ICBC that we owned as of October 20, 2006. We may
transfer the remaining shares after October 20, 2009. A
portion of our interest is held by investment funds managed
by Goldman Sachs.
We also have an investment in the convertible preferred stock
of SMFG. This investment is valued using a model that is
principally based on SMFG’s common stock price. As of
November 2007, the conversion price of our SMFG convertible
preferred stock into shares of SMFG common stock was
¥318,800. This price is subject to downward adjustment if
the price of SMFG common stock at the time of conversion is
less than the conversion price (subject to a floor of ¥105,100).
As a result of downside protection on the conversion stock
price, the relationship between changes in the fair value of
our investment and changes in SMFG’s common stock price
would be nonlinear for a significant decline in the SMFG
common stock price. As of November 2007, we had hedged
approximately 90% of the common stock underlying our
investment in SMFG and there were no restrictions on our
ability to hedge the remainder.
CASH INSTRUMENTS. Cash instruments include cash trading
instruments, public principal investments and private principal
investments.
■
CASH TRADING INSTRUMENTS. Our cash trading instruments
are generally valued using quoted market prices in active
markets, broker or dealer quotations, or alternative pricing
sources with reasonable levels of price transparency. The
types of instruments valued based on quoted market prices in
active markets include most U.S. government and agency
securities, many other sovereign government obligations,
active listed equities and most money market securities.
The types of instruments valued based on quoted prices in
markets that are not active, broker or dealer quotations, or
alternative pricing sources with reasonable levels of price
transparency include most investment-grade and high-yield
corporate bonds, most mortgage products, certain corporate
bank and bridge loans, less liquid listed equities, state,
municipal and provincial obligations, most physical
commodities and certain loan commitments.
Certain cash trading instruments trade infrequently and
therefore have little or no price transparency. Such instruments
include private equity and real estate fund investments,
certain corporate bank and bridge loans, less liquid mortgage
whole loans, distressed debt instruments and certain loan
commitments. The transaction price is initially used as the
best estimate of fair value. Accordingly, when a pricing model
is used to value such an instrument, the model is adjusted so
that the model value at inception equals the transaction price.
This valuation is adjusted only when changes to inputs and
assumptions are corroborated by evidence such as transactions
in similar instruments, completed or pending third-party
transactions in the underlying investment or comparable
entities, subsequent rounds of financing, recapitalizations and
other transactions across the capital structure, offerings in the
equity or debt capital markets, and changes in financial ratios
or cash flows.
For positions that are not traded in active markets or are
subject to transfer restrictions, valuations are adjusted to reflect
illiquidity and/or non-transferability, and such adjustments
are generally based on available market evidence. In the
absence of such evidence, management’s best estimate is used.
45Goldman Sachs 2007 Annual Report