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Rothschild & Co | Annual Report 2017
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1. Overview
4. Financial statements
3.
Management report
2. Business review
Derivatives
Derivatives are classified in Level 2 in the following circumstances:
• fair value is predominantly derived from prices or quotations of other Level 1 and Level 2 instruments, through standard market extrapolation or
interpolation or through corroboration by real transactions; or
• fair value is derived from other standard techniques and models. The most frequently used measurement model is the discounted cash flow technique
(DCF). The values derived from these models are materially affected by the measurement assumptions used, such as the amounts and settlement
dates of future cash flows, the discount rates and solvency. When those parameters are determined on the basis of directly observable inputs, the
derivatives are classified in Level 2.
Debt securities
Level 2 debt securities are less liquid than Level 1 securities. They are predominantly government bonds, corporate debt securities, mortgage-backed
securities, and certificates of deposit. They can be classified in Level 2 when external prices for the same security can be regularly observed from a
reasonable number of market makers that are active in this security, but these prices do not represent directly tradable prices (when supplied, for example,
by consensus pricing services with a reasonable number of contributors that are active market makers as well as indicative runs from active brokers and/
or dealers). Where prices are not directly observable in the market, a DCF valuation is used. The discount rate is adjusted for the applicable credit margin
determined by similar instruments listed on an active market for comparable counterparties.
Equity securities
In the absence of a price available on an active market, fair value of Level 2 equity securities is determined using parameters derived from market
conditions, based on data from comparable companies at the closing date.
The measurement techniques of Level 2 equity securities are:
• Transaction multiples
The preferred measurement technique is based on transaction multiples. This technique uses recent transactions in the sector under consideration.
Multiples are established based on the enterprise value of comparable transactions and accounting measures such as EBITDA, EBIT or profit, which
are applied to the asset to be measured.
• Earnings multiples
This consists of applying a multiple to the earnings of the company to be valued. It is based on multiples from a sample of listed companies, which are in the
peer group of the company to be valued. The earnings multiples used are the price/earnings ratio (PER), enterprise value/earnings before interest and tax
(EV/EBIT) and enterprise value/earnings before interest, tax, depreciation and amortisation (EV/EBITDA). These are historical multiples of the company to be
valued and of the peer-group companies. They are restated to exclude all non-recurring and exceptional amounts, as well as the amortisation of goodwill.
Companies in the selected peer group must operate in a similar sector to that of the target company. They are of a relatively comparable size and have
similar growth prospects. Specific factors may also be taken into account in the selection: country, regulatory aspects specific to each market, and the
presence or otherwise of related business activities.
The value of the peer group companies is obtained by adding together the market capitalisation, net financial debt and non-controlling interests, based on
the most recently available financial data.
Stock exchange multiples are calculated excluding any control premium. The valuation is made from the point of view of a non-controlling shareholder. However,
if the investment to be valued is not listed, the lack of liquidity relative to listed companies in the peer group may be reflected through an illiquidity discount.
• Measurement of share subscription warrants
Securities providing access to the capital, which generally take the form of share subscription warrants, are regularly assessed to determine the probability
of exercise and the possible impact thereof on the value of the investment. At each closing date, the probability of exercise of the warrants is determined by
comparing the cost of exercise with the expected benefit derived from exercise.
• Historical cost
When the Group has recently made an investment in an unquoted instrument, the transaction price (i.e. an entry price) is often considered as a reasonable
starting point for measuring the fair value of this unquoted equity instrument at the measurement date.
• Net assets
Net asset value is, for a company, the amount a shareholder would receive if the company sold all its assets at their current market value, paid off any
outstanding debts with the proceeds, and then distributed the remainder to the stockholders. For funds, the net asset value is based on the value of
securities and working capital held in a fund’s portfolio.