Goldman Sachs 2015 Annual Report Download - page 149

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
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 traded on an exchange (exchange-traded) or they may be
privately negotiated contracts, which are usually referred to
as OTC derivatives. Certain of the firm’s OTC derivatives
are cleared and settled through central clearing
counterparties (OTC-cleared), while others are bilateral
contracts between two counterparties (bilateral OTC).
Market-Making. As a market maker, the firm enters into
derivative transactions to provide liquidity to clients and to
facilitate the transfer and hedging of their risks. 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 its 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 interest rate exposure in certain fixed-
rate unsecured long-term and short-term borrowings, and
deposits, and to manage foreign currency exposure on the
net investment in certain non-U.S. operations.
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 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
(counterparty netting). Derivatives are accounted for at fair
value, net of cash collateral received or posted under
enforceable credit support agreements (cash collateral
netting). 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. Realized and unrealized gains and
losses on derivatives not designated as hedges under
ASC 815 are included in “Market making” and “Other
principal transactions” in Note 4.
Goldman Sachs 2015 Form 10-K 137