Morgan Stanley 2010 Annual Report Download - page 110

Counterparty Exposure Related to the Company’s Own Spreads.
The credit spread risk relating to the Company’s own mark-to-market derivative counterparty exposure is
managed separately from VaR. The credit spread risk sensitivity of this exposure corresponds to an increase in
value of approximately $8 million for each +1 basis point widening in the Company’s credit spread level for both
December 31, 2010 and December 31, 2009.
Funding Liabilities.
The credit spread risk and interest rate risk associated with non-mark-to-market funding liabilities related to fixed
and other Non-trading assets are also excluded from VaR. At December 31, 2010 and December 31, 2009,
non-mark-to-market funding liabilities related to fixed and other Non-trading assets were approximately $3.5
billion and $7.7 billion, respectively. The $4.2 billion reduction reflects a decision by the Company to swap this
amount of fixed-rate debt to a floating rate and is now included in the Non-trading VaR.
The Company’s VaR does not capture the credit spread risk sensitivity of the Company’s mark-to-market
funding liabilities, which corresponded to an increase in value of approximately $14 million and $11 million for
each +1 basis point widening in the Company’s credit spread level at December 31, 2010 and December 31,
2009, respectively. The increased credit spread sensitivity is driven by greater issuances of structured notes.
Interest Rate Risk Sensitivity on Income from Continuing Operations.
The Company measures the interest rate risk of certain assets and liabilities not included in Trading VaR by
calculating the hypothetical sensitivity of Income from continuing operations (before income taxes) to potential
changes in the level of interest rates over the next 12 months. This sensitivity analysis includes positions that are
mark-to-market as well as positions that are accounted for on an accrual basis.
Given the currently low interest rate environment, the Company uses the following two interest rate scenarios to
quantify the Company’s sensitivity: instantaneous parallel shocks of +100 basis points and +200 basis points to
all yield curves simultaneously. With respect to MSSB, the Company’s assessment of interest rate risk focuses on
its economic investment in MSSB (the Company’s 51% share of MSSB’s income from continuing operations
before income taxes). These results can be seen in the table below.
December 31, 2010
+100 Basis Points +200 Basis Points
(dollars in millions)
Impact on income from continuing operations before income taxes ......... $560 $1,084
Impact on income from continuing operations before income taxes, excluding
Citi’s interest in MSSB(1) ........................................ 343 664
(1) Amounts reflect the exclusion of the portion of income from continuing operations before income and taxes associated with MSSB’s
noncontrolling interest in the joint venture.
For non-interest-bearing positions and for interest-sensitive positions that are not mark-to-market, the Company
measures the incremental impact of the funding expense or coupon accrual over the next 12 months. For interest
rate-sensitive positions that are mark-to-market, the sensitivities include the income impact of the instantaneous
yield curve shock. The income impact of the yield curve shock measures the present value over the life of the
position. For interest rate derivatives that are perfect economic hedges to non-mark-to-market assets or liabilities,
the disclosed sensitivities include only the impact of the coupon accrual mismatch. This treatment avoids the
distorting effects of accounting differences between the hedge and the corresponding hedged instrument.
The hypothetical model does not assume any growth, change in business focus, asset pricing philosophy or asset/
liability funding mix and does not capture how the Company would respond to significant changes in market
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