Morgan Stanley 2010 Annual Report Download - page 137

MORGAN STANLEY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Financial Instruments Measured at Fair Value. All of the instruments within Financial instruments owned and
Financial instruments sold, not yet purchased, are measured at fair value, either through the fair value option
election (discussed below) or as required by other accounting guidance. These financial instruments primarily
represent the Company’s trading and investment activities and include both cash and derivative products. In
addition, debt securities classified as Securities available for sale are measured at fair value in accordance with
accounting guidance for certain investments in debt securities. Furthermore, Securities received as collateral and
Obligation to return securities received as collateral are measured at fair value as required by other accounting
guidance. Additionally, certain Deposits, certain Commercial paper and other short-term borrowings (structured
notes), certain Other secured financings, certain Securities sold under agreements to repurchase and certain
Long-term borrowings (primarily structured notes) are measured at fair value through the fair value option
election.
Gains and losses on all of these instruments carried at fair value are reflected in Principal transactions—Trading
revenues, Principal transactions—Investments revenues or Investment banking revenues in the consolidated
statements of income, except for Securities available for sale (see “Securities Available for Sale” section herein
and Note 5) and derivatives accounted for as hedges (see “Hedge Accounting” section herein and Note 12).
Interest income and expense are recorded within the consolidated statements of income depending on the nature
of the instrument and related market conventions. When interest is included as a component of the instruments’
fair value, interest is included within Principal transactions—Trading revenues or Principal transactions—
Investments revenues. Otherwise, it is included within Interest income or Interest expense. Dividend income is
recorded in Principal transactions—Trading revenues or Principal transactions—Investments revenues depending
on the business activity. The fair value of over-the-counter (“OTC”) financial instruments, including derivative
contracts related to financial instruments and commodities, is presented in the accompanying consolidated
statements of financial condition on a net-by-counterparty basis, when appropriate. Additionally, the Company
nets the fair value of cash collateral paid or received against the fair value amounts recognized for net derivative
positions executed with the same counterparty under the same master netting arrangement.
Fair Value Option. The fair value option permits the irrevocable fair value option election on an
instrument-by-instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a
new basis of accounting for that instrument. The Company applies the fair value option for eligible instruments,
including certain loans and lending commitments, certain equity method investments, certain securities sold
under agreements to repurchase, certain structured notes, certain time deposits and certain other secured
financings.
Fair Value Measurement—Definition and Hierarchy. Fair value is defined as the price that would be received
to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market
participants at the measurement date.
In determining fair value, the Company uses various valuation approaches and establishes a hierarchy for inputs
used in measuring fair value that maximizes the use of relevant observable inputs and minimizes the use of
unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are
inputs that market participants would use in pricing the asset or liability developed based on market data obtained
from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s
assumptions about the assumptions other market participants would use in pricing the asset or liability developed
based on the best information available in the circumstances. The hierarchy is broken down into three levels
based on the observability of inputs as follows:
• Level 1—Valuations based on quoted prices in active markets for identical assets or liabilities that the
Company has the ability to access. Valuation adjustments and block discounts are not applied to Level 1
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