Goldman Sachs 2009 Annual Report Download - page 97

Goldman Sachs 2009 Annual Report
95
Notes to Consolidated Financial Statements
when changes to inputs and assumptions are corroborated
by evidence such as transactions in similar instruments,
completed or pending third-party transactions in the
underlying investment or comparable entities, subsequent
rounds of  nancing, recapitalizations and other transactions
across the capital structure, offerings in the equity or debt
capital markets, and changes in  nancial ratios or
cash ows.
For positions that are not traded in active markets or are
subject to transfer restrictions, valuations are adjusted
to re ect illiquidity and/or non-transferability. Such
adjustments are generally based on market evidence where
available. In the absence of such evidence, management’s
best estimate is used.
▪
Derivative Contracts. Derivative contracts can be exchange-
traded or over-the-counter (OTC). Exchange-traded
derivatives typically fall within level1 or level2 of the fair
value hierarchy depending on whether they are deemed
to be actively traded or not. The  rm generally values
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. In such cases, exchange-
traded derivatives are classi ed within level2 of the fair
valuehierarchy.
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. The  rm generally uses 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. OTC derivatives are classi ed within level2 of the
fair value hierarchy when all of the signi cant inputs can be
corroborated to market evidence.
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. Such
instruments are classi ed within level3 of the fair value
hierarchy. Where the  rm does 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. The
valuations of these less liquid OTC derivatives are typically
based on level1 and/or level2 inputs that can be observed
in the market, as well as unobservable level3 inputs.
Subsequent to initial recognition, the  rm updates the level1
and level2 inputs to re ect observable market changes, with
resulting gains and losses re ected within level3. Level3
inputs are only changed when corroborated by evidence such
as similar market transactions, third-party pricing services
and/or broker or dealer quotations, or other empirical
market data. In circumstances where the  rm 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.
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.
Collateralized Agreements and Financings. Collateralized
agreements consist of resale agreements and securities
borrowed. Collateralized  nancings consist of repurchase
agreements, securities loaned and other secured  nancings.
Interest on collateralized agreements and collateralized
 nancings is recognized in “Interest income” and “Interest
expense,” respectively, in the consolidated statements of
earnings over the life of the transaction. Collateralized
agreements and  nancings are presented on a net-by-
counterparty basis when a right of setoff exists.