Portfolio Valuation Hard-to-Value Securities

Portfolio Valuation Hard-to-Value Securities July 30, 2008

Discussion Topics • The Audit Process Around Fair Value • Valuation - Leading Practices for Private Investments and Illiquid Securities • FAS 157 Overview

The Audit Process Around Fair Value In connection with the audit of an entity’s financial statements, the auditor will evaluate whether an entity’s fair value measurements and disclosures in the financial statements are in conformity with Generally Accepted Accounting Principles. The auditor will confirm his/her understanding of management’s valuation methodology and assess the reasonableness of the significant assumptions utilized by management to value the entity’s investments.

The Audit Process Around Fair Value(continued) More specifically, the audit process will include: • A review of management’s valuation policies. • A review of management’s controls in place around the valuation process. • A review of management’s documentation (i.e. valuation memos and analyses) for each investment.

The Audit Process Around Fair Value(continued) • A review of the reasonableness of management’s selection of valuation methodology (such as market approach or income approach) applied in valuing each type of investment. • A review of the source and management’s rationale for all inputs and underlying assumptions utilized in the valuation models (such as discount rates, growth rates, probabilities, multiples, etc.). • A review of qualitative information (i.e. company/industry performance, evolution of the mark, investment background, etc.) used by management in determining fair value. • A review of support for changes in valuation methodology or material exceptions taken to management’s valuation policies.

The Audit Process Around Fair Value(continued) • A review of management’s procedures to determine if third party broker quotes, inputs, spreads, curves, etc. represent “exit price” as defined by FAS 157. • Obtaining an understanding of management’s exit strategies for each investment. • A review of the work of third party valuation specialists that have been engaged by management. • A review of the reasonableness of financial statement disclosures and management’s assessment of the appropriateness of leveling (Level 1, 2,3) under FAS 157.

Valuation - Leading Practices for Private Investments and Illiquid Securities General Leading Practices include the following:

Valuation - Leading Practices for Private Investments and Illiquid Securities (continued) Private InvestmentLeading Practices include the following:

Valuation - Leading Practices for Private Investments and Illiquid Securities (continued) Private Investment Leading Practices include the following:

Valuation - Leading Practices for Private Investments and Illiquid Securities (continued) Illiquid Securities Leading Practices include the following:

FAS 157 Overview • FAS 157 defines Fair Value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date” • Establishes a framework / approach for measuring fair value • Imposes a “Fair Value Hierarchy” that gives priority to observable, market-based inputs in either Level I, II or III • Expands disclosures about the use of fair value to allow users to assess the relative reliability of Fair Value measurements and the impact on earnings of Level 3 measurements

FAS 157 Overview (continued)

Valuation Example In pricing a fund’s month end portfolio, management is determining the fair value of a mortgage backed security. A rating agency has priced the security at 85. A broker has provided a bid of 20 and a counterparty is executing a repo with the fund at 65. Which of these values is the appropriate fair value? 1) 85 2) 20 3) 65 4) I don’t know

Thank you

Portfolio Valuation Hard-to-Value Securities