Goldman Sachs 2012 Annual Report Download - page 130

Notes to Consolidated Financial Statements
Note 7.
Derivatives and Hedging Activities
Derivative Activities
Derivatives are instruments that derive their value from
underlying asset prices, indices, reference rates and other
inputs, or a combination of these factors. Derivatives may
be privately negotiated contracts, which are usually referred
to as over-the-counter (OTC) derivatives, or they may be
listed and traded on an exchange (exchange-traded).
Market-Making. As a market maker, the firm enters into
derivative transactions to provide liquidity and to facilitate
the transfer and hedging of risk. In this capacity, the firm
typically acts as principal and is consequently required to
commit capital to provide execution. As a market maker, it
is essential to maintain an inventory of financial
instruments sufficient to meet expected client and
market demands.
Risk Management. The firm also enters into derivatives to
actively manage risk exposures that arise from
market-making and investing and lending activities in
derivative and cash instruments. The firm’s holdings and
exposures are hedged, in many cases, on either a portfolio
or risk-specific basis, as opposed to an
instrument-by-instrument basis. The offsetting impact of
this economic hedging is reflected in the same business
segment as the related revenues. In addition, the firm may
enter into derivatives designated as hedges under U.S.
GAAP. These derivatives are used to manage foreign
currency exposure on the net investment in certain non-U.S.
operations and to manage interest rate exposure in certain
fixed-rate unsecured long-term and short-term borrowings,
and deposits.
The firm enters into various types of derivatives, including:
‰Futures and Forwards. Contracts that commit
counterparties to purchase or sell financial instruments,
commodities or currencies in the future.
‰Swaps. Contracts that require counterparties to
exchange cash flows such as currency or interest payment
streams. The amounts exchanged are based on the
specific terms of the contract with reference to specified
rates, financial instruments, commodities, currencies
or indices.
‰Options. Contracts in which the option purchaser has
the right, but not the obligation, to purchase from or sell
to the option writer financial instruments, commodities
or currencies within a defined time period for a
specified price.
Derivatives are accounted for at fair value, net of cash
collateral received or posted under credit support
agreements. Derivatives are reported on a
net-by-counterparty basis (i.e., the net payable or receivable
for derivative assets and liabilities for a given counterparty)
when a legal right of setoff exists under an enforceable
netting agreement. Derivative assets and liabilities are
included in “Financial instruments owned, at fair value”
and “Financial instruments sold, but not yet purchased, at
fair value,” respectively.
Substantially all gains and losses on derivatives not
designated as hedges under ASC 815 are included in
“Market making” and “Other principal transactions.”
128 Goldman Sachs 2012 Annual Report