Morgan Stanley 2015 Annual Report Download - page 239

MORGAN STANLEY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
• Derivatives may be used in the management of the U.S. Qualified Plan’s portfolio only when their possible effects
can be quantified, shown to enhance the risk-return profile of the portfolio, and reported in a meaningful and
understandable manner.
As a fundamental operating principle, any restrictions on the underlying assets apply to a respective derivative product. This
includes percentage allocations and credit quality. Derivatives are used solely for the purpose of enhancing investment in the
underlying assets and not to circumvent portfolio restrictions.
Plan assets are measured at fair value using valuation techniques that are consistent with the valuation techniques applied to
the Company’s major categories of assets and liabilities as described in Note 3. Quoted market prices in active markets are
the best evidence of fair value and are used as the basis for the measurement, if available. If a quoted market price is
available, the fair value is the product of the number of trading units multiplied by the market price. If a quoted market price
is not available, the estimate of fair value is based on the valuation approaches that maximize use of observable inputs and
minimize use of unobservable inputs.
The fair value of OTC derivative contracts is derived primarily using pricing models, which may require multiple market
input parameters. Derivative contracts are presented on a gross basis prior to cash collateral or counterparty netting.
Derivatives consist of investments in interest rate swap contracts and are categorized in Level 2 of the fair value hierarchy.
Commingled trust funds are privately offered funds available to institutional clients that are regulated, supervised and subject
to periodic examination by a U.S. federal or state agency. The trust must be maintained for the collective investment or
reinvestment of assets contributed to it from U.S. tax-qualified employee benefit plans maintained by more than one
employer or controlled group of corporations. The sponsor of the commingled trust funds values the funds’ NAV based on
the fair value of the underlying securities. The underlying securities of the commingled trust funds consist of mainly long-
duration fixed income instruments. Commingled trust funds that are redeemable at the measurement date or in the near future
are categorized in Level 2 of the fair value hierarchy; otherwise, they are categorized in Level 3 of the fair value hierarchy.
Some non-U.S.-based plans hold foreign funds that consist of investments in foreign corporate equity funds, foreign fixed
income funds, foreign target cash flow funds and foreign liquidity funds. Foreign corporate equity funds and foreign fixed
income funds invest in individual securities quoted on a recognized stock exchange or traded in a regulated market. Certain
fixed income funds aim to produce returns consistent with certain Financial Times Stock Exchange indexes. Foreign target
cash flow funds are designed to provide a series of fixed annual cash flows over five or 10 years achieved by investing in
government bonds and derivatives. Foreign liquidity funds place a high priority on capital preservation, stable value and a
high liquidity of assets. Foreign funds are generally categorized in Level 2 of the fair value hierarchy as they are readily
redeemable at their NAV. Corporate equity funds actively traded on an exchange are categorized in Level 1 of the fair value
hierarchy.
Other investments held by non-U.S.-based plans consist of real estate funds, hedge funds and pledged insurance annuity
contracts. These real estate and hedge funds are categorized in Level 2 of the fair value hierarchy to the extent that they are
readily redeemable at their NAV; otherwise, they are categorized in Level 3 of the fair value hierarchy. The pledged
insurance annuity contracts are valued based on the premium reserve of the insurer for a guarantee that the insurer has given
to the employee benefit plan that approximates fair value. The pledged insurance annuity contracts are categorized in Level 3
of the fair value hierarchy.
233