Barclays 2010 Annual Report Download - page 260

Notes to the financial statements
For the year ended 31st December 2010 continued
41 Fair value of financial instruments continued
Funds and fund-linked products
This category includes holdings in hedge funds, funds of funds, and fund derivatives. Fund derivatives are derivatives whose underlyings include mutual
funds, hedge funds, fund indices and multi-asset portfolios. They are valued using underlying fund prices, yield curves and other available market
information.
In general fund holdings are valued based on the latest available valuation received from the fund administrator. Funds are deemed unobservable where
the fund is either suspended, in wind-down, has a redemption restriction that severely affects liquidity, or where the latest net asset value from the fund
administrators is more than three months old. In the case of illiquid fund holdings the valuation will take account of all available information in relation to
the underlying fund or collection of funds and maybe adjusted relative to the performance of relevant index benchmarks.
Foreign exchange products
These products are derivatives linked to the foreign exchange market. This category includes forward contracts, FX swaps and FX options. Exotic
derivatives are valued using industry standard and bespoke models.
Fair value is based on input parameters that include FX rates, interest rates, FX volatilities, interest rate volatilities, FX interest rate correlations and other
model parameters. Certain correlations and long dated forward and volatilities are unobservable. Unobservable model inputs are set by referencing liquid
market instruments and applying extrapolation techniques to match the risk profile of the trading portfolio. These are validated against consensus
market data services.
Interest rate products
These are products linked to interest rates or inflation indices. This category includes interest rate and inflation swaps, swaptions, caps, floors,
inflation options, balance guaranteed swaps and other exotic interest rate derivatives. Interest rate products are valued using standard discounted
cash flow techniques.
Interest rate derivative cash flows are valued using interest rates yield curves whereby observable market data is used to construct the term structure of
forward rates. This is then used to project and discount future cash flows based on the parameters of the trade. An instrument with optionality is valued
using a volatility surface constructed from market observable inputs. Exotic interest rate derivatives are valued using industry standard and bespoke
models based on observable market parameters which are determined separately for each parameter and underlying instrument. Where unobservable,
a parameter will be set with reference to an observable proxy.
For inflation swaps, the inflation adjusted yield curve is the most significant input in the overall valuation. In an inflation swap, an inflation based cash
flow is swapped for either a fixed or floating interest rate cash flow. Flows on the inflation leg of the trades are projected using the relevant inflation
forward curve and discounted. Any floating rates will be projected using the relevant interest rate yield curve and discounted. Inflation forward curves
and interest rate yield curves are extrapolated beyond observable tenors and verified against any available market data.
Balance guaranteed swaps are valued using industry standard cash flow models that calculate fair value based on loss projections, prepayment, recovery
and discount rates. These parameters are determined by reference to underlying asset performance, independent research, ABX indices, broker quotes,
observable trades on similar securities and third party pricing sources. Prepayment is projected based on observing historic prepayment.
During 2010, in line with changes in market practice, the methodology for valuing certain collateralised interest rate products was updated to make use
of more relevant interest rate yield curves to discount cash flows. For certain collateralised vanilla swaps, inflation derivatives and other linear fixed
income derivatives Overnight Indexed Swap (OIS) rates were used rather than other market reference rates such as LIBOR.
Commodity products
These products are exchange traded and OTC derivatives based on an underlying commodity such as metals, oil and oil related, agriculturals, power and
natural gas.
Valuation inputs of certain commodity swaps and options are determined using models incorporating discounting of cash flows and other industry
standard modelling techniques. Fair value is calculated using inputs such as forward curves, volatility surfaces and tenor correlation. Unobservable inputs
are set with reference to similar observable products or by applying extrapolation techniques from the observable market.
Other
This category is largely made up of fixed rate loans, which are valued using models that discount expected future cash flows. These models calculate the
fair value based on observable interest rates and unobservable funding or credit spreads. Unobservable funding or credit spreads are determined by
applying extrapolation of observable spreads.
The receivables resulting from the acquisition of the North American businesses of Lehman Brothers is included within ‘Other’. For more details, refer to
Note 26 Legal Proceedings.
258 Barclays PLC Annual Report 2010 www.barclays.com/annualreport10