Morgan Stanley 2014 Annual Report Download - page 180

MORGAN STANLEY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
are categorized in Level 3 of the fair value hierarchy. Mortgage loans are presented within Loans and
lending commitments in the fair value hierarchy table.
•Auction Rate Securities (“ARS”). The Company primarily holds investments in Student Loan Auction
Rate Securities (“SLARS”) and Municipal Auction Rate Securities (“MARS”), which are floating rate
instruments for which the rates reset through periodic auctions. SLARS are ABS backed by pools of
student loans. MARS are municipal bonds often wrapped by municipal bond insurance. The fair value of
ARS is primarily determined using recently executed transactions and market price quotations, obtained
from independent external parties such as vendors and brokers, where available. The Company uses an
internally developed methodology to discount for the lack of liquidity and non-performance risk where
independent external market data are not available.
Inputs that impact the valuation of SLARS are independent external market data, recently executed
transactions of comparable ARS, the underlying collateral types, level of seniority in the capital structure,
amount of leverage in each structure, credit rating and liquidity considerations. Inputs that impact the
valuation of MARS are recently executed transactions, the maximum rate, quality of underlying issuers/
insurers and evidence of issuer calls/prepayment. ARS are generally categorized in Level 2 of the fair
value hierarchy as the valuation technique relies on observable external data. SLARS and MARS are
presented within Asset-backed securities and State and municipal securities, respectively, in the fair value
hierarchy table.
Corporate Equities.
• Exchange-Traded Equity Securities. Exchange-traded equity securities are generally valued based on
quoted prices from the exchange. To the extent these securities are actively traded, valuation adjustments
are not applied, and they are categorized in Level 1 of the fair value hierarchy; otherwise, they are
categorized in Level 2 or Level 3 of the fair value hierarchy.
• Unlisted Equity Securities. Unlisted equity securities are valued based on an assessment of each
underlying security, considering rounds of financing and third-party transactions, discounted cash flow
analyses and market-based information, including comparable company transactions, trading multiples
and changes in market outlook, among other factors. These securities are generally categorized in Level 3
of the fair value hierarchy.
• Fund Units. Listed fund units are generally marked to the exchange-traded price or net asset value
(“NAV”) and are categorized in Level 1 of the fair value hierarchy if actively traded on an exchange or in
Level 2 of the fair value hierarchy if trading is not active. Unlisted fund units are generally marked to
NAV and categorized as Level 2; however, positions that are not redeemable at the measurement date or
in the near future are categorized in Level 3 of the fair value hierarchy.
Derivative and Other Contracts.
• Listed Derivative Contracts. Listed derivatives that are actively traded are valued based on quoted
prices from the exchange and are categorized in Level 1 of the fair value hierarchy. Listed derivatives that
are not actively traded are valued using the same approaches as those applied to OTC derivatives; they are
generally categorized in Level 2 of the fair value hierarchy.
•OTC Derivative Contracts. OTC derivative contracts include forward, swap and option contracts related to
interest rates, foreign currencies, credit standing of reference entities, equity prices or commodity prices.
Depending on the product and the terms of the transaction, the fair value of OTC derivative products can
be either observed or modeled using a series of techniques and model inputs from comparable
benchmarks, including closed-form analytic formulas, such as the Black-Scholes option-pricing model,
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