American Express 2014 Annual Report Download - page 105

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AMERICAN EXPRESS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
When quoted prices of identical investment securities in active markets are not available, the fair values for the Company’s investment
securities are obtained primarily from pricing services engaged by the Company, and the Company receives one price for each security. The
fair values provided by the pricing services are estimated using pricing models, where the inputs to those models are based on observable
market inputs or recent trades of similar securities. Such investment securities are classified within Level 2 of the fair value hierarchy. The
inputs to the valuation techniques applied by the pricing services vary depending on the type of security being priced but are typically
benchmark yields, benchmark security prices, credit spreads, prepayment speeds, reported trades and broker-dealer quotes, all with
reasonable levels of transparency. The pricing services did not apply any adjustments to the pricing models used. In addition, the Company
did not apply any adjustments to prices received from the pricing services.
The Company reaffirms its understanding of the valuation techniques used by its pricing services at least annually. In addition, the
Company corroborates the prices provided by its pricing services for reasonableness by comparing the prices from the respective pricing
services to valuations obtained from different pricing sources. In instances where price discrepancies are identified between different pricing
sources, the Company evaluates such discrepancies to ensure that the prices used for its valuation represent the fair value of the underlying
investment securities. Refer to Note 5 for additional fair value information.
Derivative Financial Instruments
The fair value of the Company’s derivative financial instruments is estimated by third-party valuation services that use proprietary pricing
models or by internal pricing models, where the inputs to those models are readily observable from actively quoted markets. The pricing
models used are consistently applied and reflect the contractual terms of the derivatives as described below. The Company reaffirms its
understanding of the valuation techniques used by the third-party valuation services at least annually. The Company’s derivative instruments
are classified within Level 2 of the fair value hierarchy.
The fair value of the Company’s interest rate swaps is determined based on a discounted cash flow method using the following significant
inputs: the contractual terms of the swap such as the notional amount,fixedcouponrate,floatingcouponrate(basedoninterbankrates
consistent with the frequency and currency of the interest cash flows) and tenor, as well as discount rates consistent with the underlying
economic factors of the currency in which the cash flows are denominated.
The fair value of the Company’s total return contract, which served as a hedge against the Hong Kong dollar (HKD) change in fair value
associated with the Company’s investment in ICBC, is determined based on a discounted cash flow method using the following significant
inputs as of the valuation date: number of shares of the Company’s underlying ICBC investment, the quoted market price of the shares in
HKD and the monthly settlement terms of the contract inclusive of price and tenor.
The fair value of foreign exchange forward contracts is determined based on a discounted cash flow method using the following
significant inputs: the contractual terms of the forward contracts such as the notional amount, maturity dates and contract rate, as well as
relevant foreign currency forward curves, and discount rates consistent with the underlying economic factors of the currency in which the
cash flows are denominated.
Credit valuation adjustments are necessary when the market parameters, such as a benchmark curve, used to value derivatives are not
indicative of the credit quality of the Company or its counterparties. The Company considers the counterparty credit risk by applying an
observable forecasted default rate to the current exposure. Refer to Note 14 for additional fair value information.
105