Morgan Stanley 2015 Annual Report Download - page 166

MORGAN STANLEY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Alternatively, a price-to-price basis can be assumed between the comparable instrument and bond being valued in
order to establish the value of the bond. Additionally, as the probability of default increases for a given bond (i.e.,as
the bond becomes more distressed), the valuation of that bond will increasingly reflect its expected recovery level
assuming default. The decision to use price-to-price or yield/spread comparisons largely reflects trading market
convention for the financial instruments in question. Price-to-price comparisons are primarily employed for RMBS,
CMBS, ABS, CDOs, CLOs, Other debt, interest rate contracts, foreign exchange contracts, Other secured financings
and distressed corporate bonds. Implied yield (or spread over a liquid benchmark) is utilized predominately for non-
distressed corporate bonds, loans and credit contracts.
•Comparable equity price—a price derived from equity raises, share buybacks and external bid levels, etc. A
discount or premium may be included in the fair value estimate.
•Correlation—a pricing input where the payoff is driven by more than one underlying risk. Correlation is a measure
of the relationship between the movements of two variables (i.e., how the change in one variable influences a
change in the other variable). Credit correlation, for example, is the factor that describes the relationship between
the probability of individual entities to default on obligations and the joint probability of multiple entities to default
on obligations.
•Credit spread—the difference in yield between different securities due to differences in credit quality. The credit
spread reflects the additional net yield an investor can earn from a security with more credit risk relative to one with
less credit risk. The credit spread of a particular security is often quoted in relation to the yield on a credit risk-free
benchmark security or reference rate, typically either U.S. Treasury or London Interbank Offered Rate (“LIBOR”).
•EBITDA multiple / Exit multiple—the ratio of the Enterprise Value to EBITDA, where the Enterprise Value is the
aggregate value of equity and debt minus cash and cash equivalents. The EBITDA multiple reflects the value of the
company in terms of its full-year EBITDA, whereas the exit multiple reflects the value of the company in terms of
its full-year expected EBITDA at exit. Either multiple allows comparison between companies from an operational
perspective as the effect of capital structure, taxation and depreciation/amortization is excluded.
•Equity alpha—a parameter used in the modeling of equity hybrid prices.
•Funding spread—the difference between the general collateral rate (which refers to the rate applicable to a broad
class of U.S. Treasury issuances) and the specific collateral rate (which refers to the rate applicable to a specific type
of security pledged as collateral, such as a municipal bond). Repurchase agreements and certain other secured
financings are discounted based on collateral curves. The curves are constructed as spreads over the corresponding
overnight indexed swap (“OIS”) or LIBOR curves, with the short end of the curve representing spreads over the
corresponding OIS curves and the long end of the curve representing spreads over LIBOR.
•Implied weighted average cost of capital (“WACC”)—the WACC implied by the current value of equity in a
discounted cash flow model. The model assumes that the cash flow assumptions, including projections, are fully
reflected in the current equity value, while the debt to equity ratio is held constant. The WACC theoretically
represents the required rate of return to debt and equity investors.
•Interest rate curve—the term structure of interest rates (relationship between interest rates and the time to maturity)
and a market’s measure of future interest rates at the time of observation. An interest rate curve is used to set
interest rate and foreign exchange derivative cash flows and is a pricing input used in the discounting of any OTC
derivative cash flow.
•Price / Book ratio—the ratio used to compare a stock’s market value with its book value. The ratio is calculated by
dividing the current closing price of the stock by the latest book value per share. This multiple allows comparison
between companies from an operational perspective.
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