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Financial instrument measured at fair value

(a) Financial instruments in level 1
The fair value of financial instruments traded in active markets is based on quoted market prices at the
balance sheet date. A market is regarded as active if quoted prices are readily and regularly available
from an exchange, dealer, broker, industry group, pricing service, or regulatory agency, and those prices
represent actual and regularly occurring market transactions on an arm’s length basis. The quoted
market price used for financial assets held by the group is the current bid price. These instruments are
included in Level 1. Instruments included in Level 1 comprise primarily government bonds, corporate
bonds, treasury bills and equity investments classified as trading securities or available for sale invest-
ments.

(b) Financial instruments in level 2
The fair value of financial instruments that are not traded in an active market are determined by using
valuation techniques. These valuation techniques maximise the use of observable market data where
it is available and rely as little as possible on entity specific estimates. If all significant inputs required to
fair value an instrument are observable, the instrument is included in level 2.

If one or more of the significant inputs is not based on observable market data, the instrument is
included in Level 3. Specific valuation techniques used to value financial instruments include:
i. Quoted market prices or dealer quotes for similar instruments;
ii. The fair value of forward foreign exchange contracts is determined using forward exchange rates at
the balance sheet date, with the resulting value discounted back to present value;
iii. Other techniques, such as discounted cash flow analysis, are used to determine fair value for the
remaining financial instruments.

(c) Financial instruments in level 3
The Group uses widely recognised valuation models for determining the fair value of its financial
assets. Valuation techniques include net present value and discounted cash flow models, compar-
ison with similar instruments for which market observable prices exist and other valuation models.
Assumptions and inputs used in valuation techniques include risk-free and benchmark interest rates,
credit spreads and other premia used in estimating discount rates, bond and equity prices, foreign
currency exchange rates, equity and equity index prices and expected price volatilities and correlations.
The objective of valuation techniques is to arrive at a fair value measurement that reflects the price
that would be received to sell the asset or paid to transfer the liability in an orderly transaction between
market participants at the measurement date.

For more complex instruments, the Group uses proprietary valuation models, which are usually devel-
oped from recognised valuation models. Some or all of the significant inputs into these models may
not be observable in the market, and are derived from market prices or rates or are estimated based
on assumptions. Examples of instruments involving significant unobservable inputs include certain
Investment securities for which there is no active market. Valuation models that employ significant
unobservable inputs require a higher degree of management judgement and estimation in the deter-
mination of fair value. Management judgement and estimation are usually required for selection of the
appropriate valuation model to be used, determination of expected future cash flows on the financial
instrument being valued, determination of the probability of counterparty default and prepayments
and selection of appropriate discount rates. Fair value estimates obtained from models are adjusted
for any other factors, such as liquidity risk or model uncertainties, to the extent that the Group believes
that a third party market participant would take them into account in pricing a transaction. Fair values
reflect the credit risk of the instrument and include adjustments to take account of the credit risk of
the Group entity and the counterparty where appropriate.

For level 2 assets, fair value was obtained using a recent market transaction during the year under
review. Fair values of unquoted debt securities were derived by interpolating prices of quoted debt
secuirties with similar maturity profile and characteristics. There were no transfer between levels 1
and 2 during the year.

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Annual Report & Accounts 2017