Morgan Stanley 2010 Annual Report Download - page 199

MORGAN STANLEY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
OTC Derivative Products—Financial Instruments Owned at December 31, 2009(1)
Years to Maturity
Cross-Maturity
and
Cash Collateral
Netting(3)
Net Exposure
Post-Cash
Collateral
Net Exposure
Post-CollateralCredit Rating(2) Less than 1 1-3 3-5 Over 5
(dollars in millions)
AAA ............. $ 852 $ 2,026 $ 3,876 $ 9,331 $ (6,616) $ 9,469 $ 9,082
AA .............. 6,469 7,855 6,600 15,071 (25,576) 10,419 8,614
A ................ 8,018 10,712 7,990 22,739 (38,971) 10,488 9,252
BBB ............. 3,032 4,193 2,947 7,524 (8,971) 8,725 5,902
Non-investment
grade ........... 2,773 3,331 2,113 4,431 (4,534) 8,114 6,525
Total ......... $21,144 $28,117 $23,526 $59,096 $(84,668) $47,215 $39,375
(1) Fair values shown represent the Company’s net exposure to counterparties related to the Company’s OTC derivative products. The table
does not include listed derivatives and the effect of any related hedges utilized by the Company. The table also excludes fair values
corresponding to other credit exposures, such as those arising from the Company’s lending activities.
(2) Obligor credit ratings are determined by the Company’s Credit Risk Management Department.
(3) Amounts represent the netting of receivable balances with payable balances for the same counterparty across maturity categories.
Receivable and payable balances with the same counterparty in the same maturity category are netted within such maturity category,
where appropriate. Cash collateral received is netted on a counterparty basis, provided legal right of offset exists.
Hedge Accounting.
The Company applies hedge accounting using various derivative financial instruments and non-U.S. dollar-
denominated debt to hedge interest rate and foreign exchange risk arising from assets and liabilities not held at
fair value as part of asset and liability management and foreign currency exposure management.
The Company’s hedges are designated and qualify for accounting purposes as one of the following types of
hedges: hedges of exposure to changes in fair value of assets and liabilities being hedged (fair value hedges) and
hedges of net investments in foreign operations whose functional currency is different from the reporting
currency of the parent company (net investment hedges).
For all hedges where hedge accounting is being applied, effectiveness testing and other procedures to ensure the
ongoing validity of the hedges are performed at least monthly.
Fair Value Hedges—Interest Rate Risk. The Company’s designated fair value hedges consisted primarily of
interest rate swaps designated as fair value hedges of changes in the benchmark interest rate of fixed rate senior
long-term borrowings. The Company uses regression analysis to perform an ongoing prospective and
retrospective assessment of the effectiveness of these hedging relationships (i.e., the Company applies the “long-
haul” method of hedge accounting). A hedging relationship is deemed effective if the fair values of the hedging
instrument (derivative) and the hedged item (debt liability) change inversely within a range of 80% to 125%. The
Company considers the impact of valuation adjustments related to the Company’s own credit spreads and
counterparty credit spreads to determine whether they would cause the hedging relationship to be ineffective.
For qualifying fair value hedges of benchmark interest rates, the changes in the fair value of the derivative and
the changes in the fair value of the hedged liability provide offset of one another and, together with any resulting
ineffectiveness, are recorded in Interest expense. When a derivative is de-designated as a hedge, any basis
adjustment remaining on the hedged liability is amortized to Interest expense over the remaining life of the
liability using the effective interest method.
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