Goldman Sachs 2015 Annual Report Download - page 63

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis
Other Markets
In Brazil, real GDP appeared to contract by 3.8% in 2015
compared with an increase of 0.1% in 2014, reflecting
sharp contractions in fixed investment and private
consumption. The U.S. dollar appreciated by 49% against
the Brazilian real and, in equity markets, the Bovespa Index
decreased by 13%. In Russia, real GDP contracted by 3.7%
in 2015 compared with an increase of 0.6% in 2014,
reflecting contractions in private consumption and
investment. The U.S. dollar appreciated by 26% against the
Russian ruble and, in equity markets, the MICEX Index
increased by 26% during 2015.
Critical Accounting Policies
Fair Value
Fair Value Hierarchy. Financial instruments owned, at fair
value and Financial instruments sold, but not yet
purchased, at fair value (i.e., inventory), as well as certain
other financial assets and financial liabilities, are reflected
in our consolidated statements of financial condition at fair
value (i.e., marked-to-market), with related gains or losses
generally recognized in our consolidated statements of
earnings. The use of fair value to measure financial
instruments is fundamental to our risk management
practices and is our most critical accounting policy.
The fair value of a financial instrument is the amount that
would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market
participants at the measurement date. We measure certain
financial assets and financial liabilities as a portfolio (i.e.,
based on its net exposure to market and/or credit risks). In
determining fair value, the hierarchy under U.S. generally
accepted accounting principles (U.S. GAAP) gives (i) the
highest priority to unadjusted quoted prices in active
markets for identical, unrestricted assets or liabilities
(level 1 inputs), (ii) the next priority to inputs other than
level 1 inputs that are observable, either directly or
indirectly (level 2 inputs), and (iii) the lowest priority to
inputs that cannot be observed in market activity (level 3
inputs). Assets and liabilities are classified in their entirety
based on the lowest level of input that is significant to their
fair value measurement.
The fair values for substantially all of our financial assets
and financial liabilities are based on observable prices and
inputs and are classified in levels 1 and 2 of the fair value
hierarchy. Certain level 2 and level 3 financial assets and
financial liabilities may require appropriate valuation
adjustments that a market participant would require to
arrive at fair value for factors such as counterparty and the
firm’s credit quality, funding risk, transfer restrictions,
liquidity and bid/offer spreads.
Instruments categorized within level 3 of the fair value
hierarchy are those which require one or more significant
inputs that are not observable. As of December 2015 and
December 2014, level 3 financial assets represented 2.8%
and 4.2%, respectively, of our total assets. See Notes 5
through 8 to the consolidated financial statements for
further information about level 3 financial assets, including
changes in level 3 financial assets and related fair value
measurements. Absent evidence to the contrary,
instruments classified within level 3 of the fair value
hierarchy are initially valued at transaction price, which is
considered to be the best initial estimate of fair value.
Subsequent to the transaction date, we use other
methodologies to determine fair value, which vary based on
the type of instrument. Estimating the fair value of level 3
financial instruments requires judgments to be made. These
judgments include:
‰Determining the appropriate valuation methodology and/
or model for each type of level 3 financial instrument;
‰Determining model inputs based on an evaluation of all
relevant empirical market data, including prices
evidenced by market transactions, interest rates, credit
spreads, volatilities and correlations; and
‰Determining appropriate valuation adjustments,
including those related to illiquidity or counterparty
credit quality.
Regardless of the methodology, valuation inputs and
assumptions are only changed when corroborated by
substantive evidence.
Goldman Sachs 2015 Form 10-K 51