Inputs and Hierarchy Flashcards
Inputs
Ans:
Are various assumptions that market participants would use in determining fair value including assumptions about the risk inherent in using a particular valuation technique as well as the risk inherent in using various inputs ( data, assumptions, etc) with each valuation technique
Types of Inputs
Observable and unobservable
Observable Input
Inputs used in pricing an asset, liability, or equity item that are developed based on market data obtained from sources independent of the reporting entity
Unobservable Input
Inputs that reflect the reporting entity’s own assumptions used in pricing the asset, liability, or equity item that are developed based on the best information available in the circumstances.
Valuation Techniques
are used to maximize the use of observable inputs and minimize the use of unobservable inputs.
Fair Value Hierarchy
The fair value hierarchy prioritizes or ranks the inputs to valuation techniques used to measure fair value into three levels
Level 1
Input in this highest level are unadjusted quoted prices in active markets for assets or liabilities ( or equity items), and they are identically valued that the entity can obtain at the measurement date.
Level 1: Quotes
Quoted price are mostly reliable to measure for fair value, but in unusual circumstances, quotes should be used to measure fair value when available.
Quotes prices should not be adjusted because the entity holds a sizable position in the asset or liability relative to the trading volume in the market ( often referred to as the “ Blockage Factor”.
Adjustments to quoted prices generally result in a fair value measurement categorized in a lower level of the fair value hierarchy ( i.e., level 2 or 3).
Level 2
Inputs in this level are observable for assets or liabilities ( or equity items) either directly or indirectly , other than quoted prices described in level 1
Level 2: Quotes
1) Quoted prices for similar assets or liabilities in active markets
2) Quoted prices for identical or similar assets or liabilities in markets that are not active markets in which
there are few relevant transactions, prices are not current or vary substantially or for which little information is publicly available.
3) Inputs, other than quoted prices , that are observable for the assets or liabilities being valued, including for example, interest rates, yield curves, implied volatilities and credit spreads.
4) Input are derived principally from or corroborated by observable market data by correlation or other means (referred to as “ Market - corroborated inputs).
Level 2 inputs: adjustments
Depending on specific to the asset or liability being valued, these inputs may need to be adjusted when applied to condition, location, and the level of activity in the relevant market.
Level 2: Premium or Discount
If a premium or discount is applied to either an asset or liability, an entity should apply the premium or discount in measuring fair value.
Level 2: unobservable inputs
If significant unobservable inputs are used to adjust observable inputs, the resulting measurement may be categorized in level 3.
Level 3
Inputs in this , the lowest level, are unobservable for the assets or liabilities ( or equity items) being valued and should be used to determine fair value only to the extent observable inputs are not available.
Level 3: Unobservable inputs
Unobservable inputs should reflect the entity’s assumptions about what market participants would assume and should be developed based on the best information available in the circumstances, which might include the entity’s own data.
