Fair Value Hierarchy

1268 Words May 4th, 2014 6 Pages
Memorandum to: Accounting department of family finance co. from: Daisy subject: fair value hierarchy date: december 15, 2012
Introduction
Family Finance Co. (FFC), a publicly traded commercial bank, invests in a variety of securities in order to enhance returns greater than interest paid on bank deposits and other liabilities. The primary investments of FFC are collateralized debt obligation, mortgage-backed securities, auction-rate securities, equity securities in nonpublic companies, interest rate swaps, and a fuel swap for gasoline. FFC measures the derivative at fair value, presenting the portion of the fair value change by using the fair value hierarchy. This memo will present the appropriate classification in the fair value
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Also, as of the measurement date, there is lack of recent and relevant transactions. Thus, the fair value measurement of this CDO should be classified as Level 3. By analyzing the market changes, FFC determined that the CDO’s market was not active and there has been a significant decrease in the volume and level of activity. FFC used an income approach valuation technique which is present value technique to make measurement. Because this approach can maximize the use of relevant observable inputs and minimizes the use of unobservable inputs to reflect the fair value more representatively.
Instrument 2 —Mortgage-Backed Security The fair value measurement of the Mortgage-Backed Security investment shall be categorized within Level 2 of the fair value hierarchy. According to ASC 820-10-35-52, “Level 2 inputs include the following: a. Quoted prices for similar assets or liabilities in active markets”. These inputs included quoted prices in active markets for similar MBSs with insignificant adjustments for differences between the MBS held by FFC and similar securities. In Q4 of 2012, the prices for transactions didn’t reduce the relevant to the fair value measurement. Therefore, the fair value measurement of this MBS should be classified into Level 2 of fair value hierarchy. The market of Mortgage-Backed Security…