HSBC 2005 Annual Report Download - page 366

HSBC HOLDINGS PLC
Notes on the Financial Statements (continued)
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portfolios, securities were valued by reference to bid or offer prices as appropriate. When independent prices
were not available, market values were estimated by discounting the expected future cash flows using a suitable
interest rate adjusted for the counterparty’s credit risk. Interest income, interest expense and dividends arising
from trading assets and liabilities were aggregated in the income statement with similar amounts arising from
other activities.
Financial investments
Treasury bills, debt securities and equity shares intended to be held on a continuing basis were classified as
financial investments and included in the balance sheet at cost less provision for any permanent diminution in
value.
When dated financial investments had been purchased at a premium or discount, those premiums and discounts
were amortised through the income statement over the period from the date of purchase to the date of maturity so
as to give a constant rate of return. If the maturity was at the borrowers’ option within a specified range of years,
the earliest maturity was adopted. Those financial investments were included in the balance sheet at cost adjusted
for the amortisation of premiums and discounts arising on acquisition. The amortisation of premiums and
discounts was included in ‘Interest income’. Any gain or loss on realisation of these securities was recognised in
‘Gains less losses from financial investments’ in the income statement as it arose.
Derivatives
Derivative financial instruments comprised futures, forward, swap and option transactions undertaken by HSBC
in the foreign exchange, interest rate, equity, credit derivative, and commodity markets that were held off-
balance sheet. Netting was applied where a legal right of offset existed.
Accounting for these instruments was dependent upon whether the transactions were undertaken for trading or
non-trading purposes.
Trading transactions
Trading transactions included transactions undertaken for market-making, to service customers’ needs and for
proprietary purposes, as well as any related hedges.
Transactions undertaken for trading purposes were marked to market and the net present value of any gain or
loss arising was recognised in the income statement as ‘Trading income’, after appropriate deferrals for unearned
credit margins and future servicing costs. Derivative trading transactions were valued by reference to an
independent liquid price when this was available. For those transactions with no readily available quoted prices,
predominantly over the counter transactions, market values were determined by reference to independently
sourced rates, using valuation models. If market observable data was not available, the entire initial change in
fair value indicated by the valuation model, but based on unobservable inputs, was not recognised immediately
in the income statement. This amount was held back and recognised over the life of the transaction where
appropriate, or released to the income statement when the inputs became observable, or when the transaction
matured or was closed out. Adjustments were made for illiquid positions where appropriate.
Assets, including gains, resulting from derivative exchange rate, interest rate, equities, credit derivative and
commodity contracts which were marked to market were included in ‘Derivatives’ on the assets side of the
balance sheet. Liabilities, including losses, resulting from such contracts, were included in ‘Derivatives’ on the
liabilities side of the balance sheet.
Non-trading transactions
Non-trading transactions, which were those undertaken for hedging purposes as part of HSBC’s risk
management strategy against cash flows, assets, liabilities or positions, were measured on an accrual basis. Non-
trading transactions included qualifying hedges and positions that synthetically altered the characteristics of
specified financial instruments.
Non-trading transactions were accounted for on an equivalent basis to the underlying assets, liabilities or net
positions. Any gain or loss arising was recognised on the same basis as that arising from the related assets,
liabilities or positions.