Goldman Sachs 2009 Annual Report Download - page 43

data. In circumstances where we cannot verify the model value
to market transactions, it is possible that a different valuation
model could produce a materially different estimate of fair
value. See “— Derivatives” below for further information on
our OTC derivatives.
When appropriate, valuations are adjusted for various
factors such as liquidity, bid/offer spreads and credit
considerations. Such adjustments are generally based on
market evidence where available. In the absence of such
evidence, management’s best estimate is used.
Controls Over Valuation of Financial Instruments. A control
infrastructure, independent of the trading and investing
functions, is fundamental to ensuring that our  nancial
instruments are appropriately valued at market-clearing levels
(i.e.,exit prices) and that fair value measurements are reliable
and consistently determined.
We employ an oversight structure that includes appropriate
segregation of duties. Senior management, independent of
the trading and investing functions, is responsible for the
oversight of control and valuation policies and for reporting
the results of these policies to our Audit Committee. We
seek to maintain the necessary resources to ensure that
control functions areperformed appropriately. We employ
procedures for the approval of new transaction types and
markets, price veri cation, review of daily pro t and loss,
and review of valuation models bypersonnel with appropriate
technical knowledge of relevant products and markets. These
procedures areperformed bypersonnel independent of the
trading and investing functions. For  nancial instruments
where prices or valuations that require inputs are less
observable, we employ, where possible, procedures that
include comparisons with similar observable positions,
analysis of actual to projected cash  ows, comparisons with
subsequent sales, reviews of valuations used for collateral
management purposes and discussions with senior business
leaders. See “— Market Risk” and “— Credit Risk” below for
a further discussion of how we manage the risks inherent in
our trading and principal investing businesses.
Fair Value Hierarchy – Level 3. The fair value hierarchy under
Financial Accounting Standards Board Accounting Standards
Codi cation (ASC) 820 prioritizes the inputs to valuation
techniques used to measure fair value. The objective of a
fair value measurement is to determine the price that would
be received to sell an asset or paid to transfer a liability
By their nature, these investments have little or no price
transparency. We value such instruments initially at
transaction price and adjust valuations when evidence
is available to support such adjustments. Such evidence
includes recent third-party investments or pending
transactions, third-party independent appraisals,
transactions in similar instruments, discounted cash  ow
techniques, valuation multiples and public comparables.
Derivative Contracts. Derivative contracts can be exchange-
traded or over-the-counter (OTC). We generally value
exchange-traded derivatives using models which calibrate
to market-clearing levels and eliminate timing differences
between the closing price of the exchange-traded derivatives
and their underlying instruments.
OTC derivatives are valued using market transactions and
other market evidence whenever possible, including market-
based inputs to models, model calibration to market-clearing
transactions, broker or dealer quotations, or alternative
pricing sources with reasonable levels of price transparency.
Where models are used, the selection of a particular model
to value an OTC derivative depends upon the contractual
terms of, and speci c risks inherent in, the instrument, as
well as the availability of pricing information in the market.
We generally use similar models to value similar instruments.
Valuation models require a variety of inputs, including
contractual terms, market prices, yield curves, credit curves,
measures of volatility, voluntary and involuntary prepayment
rates, loss severity rates and correlations of such inputs. For
OTC derivatives that trade in liquid markets, such as generic
forwards, swaps and options, model inputs can generally
be veri ed and model selection does not involve signi cant
management judgment.
Certain OTC derivatives trade in less liquid markets with
limited pricing information, and the determination of fair
value for these derivatives is inherently more dif cult. Where
we do not have corroborating market evidence to support
signi cant model inputs and cannot verify the model to
market transactions, the transaction price is initially used as
the best estimate of fair value. Accordingly, when a pricing
model is used to value such an instrument, the model is
adjusted so that the model value at inception equals the
transaction price. Subsequent to initial recognition, we only
update valuation inputs when corroborated by evidence such
as similar market transactions, third-party pricing services
and/or broker or dealer quotations, or other empirical market
Goldman Sachs 2009 Annual Report
41
Management’s Discussion and Analysis