Morgan Stanley 2009 Annual Report Download - page 143

MORGAN STANLEY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The Company trades various derivative structures with commodity underlyings. Depending on the type of
structure, the model inputs generally include interest rate yield curves, commodity underlier curves,
implied volatility of the underlying commodities and, in some cases, the implied correlation between
these inputs. The fair value of these products is estimated using executed trades and broker and consensus
data to provide values for the aforementioned inputs. Where these inputs are unobservable, relationships
to observable commodities and data points, based on historic and/or implied observations, are employed
as a technique to estimate the model input values. Commodity derivatives are generally categorized in
Level 2 of the fair value hierarchy; in instances where significant inputs are unobservable, they are
categorized in Level 3 of the fair value hierarchy.
For further information on derivative instruments and hedging activities, see Note 10.
Investments.
• The Company’s investments include direct private equity investments and investments in private equity
funds, real estate funds and hedge funds. Initially, the transaction price is generally considered by the
Company as the exit price and is the Company’s best estimate of fair value.
After initial recognition, in determining the fair value of internally and externally managed funds, the
Company considers the net asset value of the fund provided by the fund manager to be the best estimate
of fair value. For direct private equity investments and privately held investments within internally
managed funds, fair value after initial recognition is based on an assessment of each underlying
investment, considering rounds of financing and third-party transactions, discounted cash flow analyses
and market-based information, including comparable company transactions, trading multiples and
changes in market outlook, among other factors.
Investments in private equity and real estate funds are generally categorized in Level 3 of the fair value
hierarchy. Investments in hedge funds that are redeemable at the measurement date or in the near future,
are categorized in Level 2 of the fair value hierarchy; otherwise they are categorized in Level 3.
Physical Commodities.
• The Company trades various physical commodities, including crude oil and refined products, natural gas,
base and precious metals and agricultural products. Fair value for physical commodities is determined
using observable inputs, including broker quotations and published indices. Physical commodities are
categorized in Level 2 of the fair value hierarchy.
Commercial Paper and Other Short-term Borrowings/Long-Term Borrowings.
• Structured Notes. The Company issues structured notes that have coupons or repayment terms linked to
the performance of debt or equity securities, indices, currencies or commodities. Fair value of structured
notes is estimated using valuation models for the derivative and debt portions of the notes. These models
incorporate observable inputs referencing identical or comparable securities, including prices that the
notes are linked to, interest rate yield curves, option volatility, and currency, commodity or equity rates.
Independent, external and traded prices for the notes are also considered. The impact of the Company’s
own credit spreads is also included based on the Company’s observed secondary bond market spreads.
Most structured notes are categorized in Level 2 of the fair value hierarchy.
Deposits.
• Time Deposits. The fair value of certificates of deposit is estimated using third-party quotations. These
deposits are generally categorized in Level 2 of the fair value hierarchy.
The following fair value hierarchy tables present information about the Company’s assets and liabilities
measured at fair value on a recurring basis as of December 31, 2009 and December 31, 2008. See Note 2 for a
discussion of the Company’s policies regarding this fair value hierarchy.
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