Morgan Stanley 2014 Annual Report Download - page 69

Trading revenues include the realized gains and losses from sales of cash instruments and derivative settlements,
unrealized gains and losses from ongoing fair value changes of the Company’s positions related to market-
making activities, and gains and losses related to investments associated with certain employee deferred
compensation plans. In many markets, the realized and unrealized gains and losses from the purchase and sale
transactions will include any spreads between bids and offers. Certain fees received on loans carried at fair value
and dividends from equity securities are also recorded in this line item since they relate to market-making
positions. Commissions received for purchasing and selling listed equity securities and options are recorded
separately in the Commissions and fees line item. Other cash and derivative instruments typically do not have
fees associated with them, and fees for related services are recorded in Commissions and fees.
The Company often invests in investments or other financial instruments to economically hedge its obligations
under its deferred compensation plans. Changes in value of such investments made by the Company are recorded
in Trading revenues and Investments revenues. Expenses associated with the related deferred compensation plans
are recorded in Compensation and benefits. Compensation expense is calculated based on the notional value of
the award granted, adjusted for upward and downward changes in fair value of the referenced investment and is
recognized ratably over the prescribed vesting period for the award. Generally, changes in compensation expense
resulting from changes in fair value of the referenced investment will be offset by changes in fair value of the
investments made by the Company. However, there may be a timing difference between the immediate revenue
recognition of gains and losses on the Company’s investments and the deferred recognition of the related
compensation expense over the vesting period.
As a market maker, the Company stands ready to buy, sell or otherwise transact with customers under a variety
of market conditions and to provide firm or indicative prices in response to customer requests. The Company’s
liquidity obligations can be explicit and obligatory in some cases, and in others, customers expect the Company
to be willing to transact with them. In order to most effectively fulfill its market-making function, the Company
engages in activities across all of its trading businesses that include, but are not limited to: (i) taking positions in
anticipation of, and in response to, customer demand to buy or sell and—depending on the liquidity of the
relevant market and the size of the position—to hold those positions for a period of time; (ii) managing and
assuming basis risk (risk associated with imperfect hedging) between customized customer risks and the
standardized products available in the market to hedge those risks; (iii) building, maintaining and rebalancing
inventory, through trades with other market participants, and engaging in accumulation activities to
accommodate anticipated customer demand; (iv) trading in the market to remain current on pricing and trends;
and (v) engaging in other activities to provide efficiency and liquidity for markets. Although not included in
Trading revenues, interest income and expense are also impacted by market-making activities as debt securities
held by the Company earn interest and securities are loaned, borrowed, sold with agreement to repurchase and
purchased with agreement to resell.
Investments. The Company’s investments generally are held for long-term appreciation and generally are
subject to significant sales restrictions. Estimates of the fair value of the investments may involve significant
judgment and may fluctuate significantly over time in light of business, market, economic and financial
conditions generally or in relation to specific transactions. In some cases, such investments are required or are a
necessary part of offering other products. The revenues recorded are the result of realized gains and losses from
sales and unrealized gains and losses from ongoing fair value changes of the Company’s holdings as well as from
investments associated with certain employee deferred compensation and co-investment plans. Typically, there
are no fee revenues from these investments. The sales restrictions on the investments relate primarily to
redemption and withdrawal restrictions on investments in real estate funds, hedge funds and private equity funds,
which include investments made in connection with certain employee deferred compensation plans (see Note 4 to
the Company’s consolidated financial statements in Item 8). Restrictions on interests in exchanges and
clearinghouses generally include a requirement to hold those interests for the period of time that the Company is
clearing trades on that exchange or clearinghouse. Additionally, there are certain investments related to assets
held by consolidated real estate funds, which are primarily related to holders of noncontrolling interests.
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