RBS 2007 Annual Report Download - page 135

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RBS Group • Annual Report and Accounts 2007
Financial statements
Deposits by banks and customer accounts (held-for-trading
and designated as at fair value though profit or loss) – deposits
measured at fair value principally include repurchase
agreements (repos) discussed above and investment contracts
issued by the Group’s life assurance businesses.
Debt securities in issue (held-for-trading and designated as at
fair value though profit or loss) – measured at fair value and
principally comprise medium term notes.
Short positions (held-for-trading) – arise in dealing and market
making activities where treasury and other eligible bills, debt
securities and equity shares are sold which the Group does
not currently possess.
Derivatives – these include swaps, forwards, futures and
options. They may be traded on an organised exchange
(exchange-traded) or over-the-counter (OTC). Holders of
exchange traded derivatives are generally required to provide
margin daily in the form of cash or other collateral.
Swaps include currency swaps, interest rate swaps, credit
default swaps, total return swaps and equity and equity index
swaps. A swap is an agreement to exchange cash flows in the
future in accordance with a pre-arranged formula. In currency
swap transactions, interest payment obligations are exchanged
on assets and liabilities denominated in different currencies;
the exchange of principal may be notional or actual. Interest
rate swap contracts generally involve exchange of fixed and
floating interest payment obligations without the exchange of
the underlying principal amounts.
Forwards include forward foreign exchange contracts and
forward rate agreements. A forward contract is a contract to
buy (or sell) a specified amount of a physical or financial
commodity, at an agreed price, on an agreed future date.
Forward foreign exchange contracts are contracts for the
delayed delivery of currency on a specified future date.
Forward rate agreements are contracts under which two
counterparties agree on the interest to be paid on a notional
deposit of a specified term starting on a specific future date;
there is no exchange of principal.
Futures are exchange-traded forward contracts to buy (or sell)
standardised amounts of underlying physical or financial
commodities. The Group buys and sells currency, interest rate
and equity futures. Options include exchange-traded options
on currencies, interest rates and equities and equity indices
and OTC currency and equity options, interest rate caps and
floors and swaptions. They are contracts that give the holder
the right but not the obligation to buy (or sell) a specified
amount of the underlying physical or financial commodity at an
agreed price on an agreed date or over an agreed period.
Fair value is the amount for which an asset could be
exchanged, or a liability settled, between knowledgeable,
willing parties in an arm’s length transaction. Fair values are
determined from quoted prices in active markets for identical
financial assets or financial liabilities where these are available.
Fair value for a net open position in a financial asset or
financial liability in an active market is the current bid or offer
price times the number of units of the instrument held. Where
a trading portfolio contains both financial assets and financial
liabilities which are derivatives of the same underlying
instrument, fair value is determined by valuing the gross long
and short positions at current mid market prices, with an
adjustment at portfolio level to the net open long or short
position to amend the valuation to bid or offer as appropriate.
Where the market for a financial instrument is not active, fair
value is established using a valuation technique. These
valuation techniques involve a degree of estimation, the extent
of which depends on the instrument’s complexity and the
availability of market-based data.