During classifications, entities are to use inputs for measuring fair value according to the three level hierarchies. We start from the highest then moving to the next until we get one which is available. The three levels used are:
Level 1: Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
Level 2: Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include:
a. Quoted prices for similar assets or liabilities in active markets;
b. Quoted prices for identical or similar assets or liabilities in markets that are not active, that is, markets in which there are few transactions for the asset or liability, the prices are not current, or price quotations vary substantially either over time or among market makers (for example, some brokered markets), or in which little information is released publicly (for example, a principal-to principal market);
c. Inputs other than quoted prices that are observable for the asset or liability (for example, interest rates and yield curves observable at commonly quoted intervals, volatilities, prepayment speeds, loss severities, credit risks, and default rates);
d. Inputs that are derived principally from or corroborated by observable market data by correlation or other means (market-corroborated inputs).
Level 3: Level 3 inputs are unobservable inputs for the asset or liability.
Unobservable inputs shall be used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date.
However, the fair value measurement objective remains the same, that is, an exit price from the perspective of a market participant that holds the asset or owes the liability.
Therefore, unobservable inputs shall reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability (including assumptions about risk).
Unobservable inputs shall be developed based on the best information available in the circumstances, which might include the reporting entity’s own data.
In developing unobservable inputs, the reporting entity need not undertake all possible efforts to obtain information about market participant assumptions.
However, the reporting entity shall not ignore information about market participant assumptions that is reasonably available without undue cost and effort. Therefore, the reporting entity’s own data used to develop unobservable inputs shall be adjusted if information is reasonably available without undue cost and effort that indicates that market participants would use different assumptions.
According to the different methods of classification above the following
1. A portfolio of exchange traded stocks. The exchanges are liquid and provide a daily price quote. These fall under level 1 whereby the inputs have quoted prices which are unadjusted in active markets for identical assets or liabilities. The reporting entity has the ability to access the measurement date.
2. A portfolio of foreign stocks. Although traded on exchanges, the company has adjusted the prices to reflect market and timing differentials. This fall under Level 2 as it consists of inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The specific aspect that makes it fall under this category is part a) which is Quoted prices for similar assets or liabilities in active markets;
3. Exchange-traded futures contracts. This fall under level 3 as there are no observable inputs for the assets or liabilities.
4. Equity in a privately-held company with restrictions over its sale. The finance department has valued this company on the basis of a discounted cash flow analysis. Last year, the company had a similar investment, but sold it during this year. Falls under level 2 as the inputs that are derived principally from or corroborated by observable market data by correlation or other means (market-corroborated inputs).
5. Foreign exchange contracts entered into with a bank as counterparty. The pricing is based on similar instruments, with observable inputs such as the yield curve included in the model. this falls under Level 2 due to the observable inputs found here.
6. Mortgage backed securities traded on a thinly traded market. Falls under level 3 as there are no observable inputs which may reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing.
7. Investments in hedge funds, without restrictions over redemption. This also falls under Level 3 where there are no observable inputs present.
Conclusion
The basis of any investment is to achieve some gains from the investment. This can be best done through performing a thorough analysis on the operation of the investment. Performing a portfolio analysis helps in evaluating the risk and some of the shares based on the historical data collected from the firm. We need to take into consideration any little turnover which may have been achieved in the past few years. In my analysis I determined correlation, yields, risks and putting more emphasis on the systemic risk of the portfolio and each individual stock in the firm. This Memo presents a technical and a financial analysis of the firm and what can be done in order to increase its profitability.
Work Cited List
Aristotle, Politics, trans. Benjamin Jowett, vol. 2, The Great Books of the Western World, book 1, chap. 11, p. 453.
Damodaran, A. (1999) Estimating risk parameter http://pages.stern.nyu.edu/~adamodar/pdfiles/ papers/beta.pdf [accessed 22.03.2010]
Diacogiannis, G. & Makri, P. (2008) Estimating betas in thinner markets: The case of the Athens Stock Exchange. International research Journal of Finance and Economics, Issue 13, pp. 108- 122
