CONTENTS 1.
INTRODUCTION…………………………………………………………………………………………………….
………..52.
BACKGROUND………………………………………………………………………………………………………
………..53. THE FAIR VALUE
MODEL…………………………………………………………………………………………………83.1
DEFINITION …………………………………………………………………………………………………………..
…..83.2 ARGUMENTS IN FAVOUR OF FULL FAIR
VALUE ………………………………………………………….93.3 CRITICISMS OF THE FAIR
VALUE MODEL………………………………………………………………….103.3.1 Relevance of fair
value for banks accounting practices ……………………………………….113.3.2 Reliability of fair
value ………………………………………………………………………………………..113.3.3
Comparability of financial
information …………………………………………………………………123.3.4 Impact on the stability
of the system……………………………………………………………………134. APPLICATION OF
THE FAIR VALUE MODEL …………………………………………………………………..134.1
GENERAL
POINTS ……………………………………………………………………………………………………134.2
APPLICATION OF FAIR VALUE TO FINANCIAL
INSTRUMENTS ……………………………………144.2.1 Instruments with an active
market………………………………………………………………………………154.2.2 Financial
instruments without a market or with a somewhat inactive market……………………..164.2.2
a) Valuation techniques and
models: …………………………………………………………………..164.2.2.b) Characteristics of
valuation techniques: ………………………………………………………….174.2.3 Information
disclosure requirements …………………………………………………………………………..205.
CONCLUSIONS……………………………………………………………………………………………………….
…….21
——————————————————————————–
Page 4
4
——————————————————————————–
Page 5
5 1. INTRODUCTION Among the traditional models for valuing financial instruments, the
most widely used has been the so-called mixed model, in which instruments held for
trading purposes are marked to market (i.e. valuedat market price) while the rest are
registered at their historic cost. Against this is the so-called fairvalue method, in which the
majority of financial instruments are recorded at their market value. In thecase of credit
institutions the application of one method or the other is of fundamental importance asthe
lions share of their balance sheet consists of financial instruments.In the last few years
legislators at national and international level have taken steps to extend theapplication of
the fair value principle to an ever greater range of assets and liabilities.This paper aims to
review the debate that has arisen as a result of the widespread application of fairvalue in
accounting and its application to financial instruments in particular. It also looks at
thepractical aspects established by the regulations relating to it. It is subdivided as follows:
first of all it presents the background to the debate on the application of the principle of
fair value; it then goes onto outline the concept and the advantages and drawbacks of its
widespread application. Then, the subtleties that need to be taken into account when
applying fair value to financial statements arediscussed, focusing on the specific practical
criteria laid down by the regulations for the registration,valuation and presentation of
financial instruments. Finally, by way of a conclusion, the paper roundsoff with a
summary.2. BACKGROUND In the 1980s, financial instruments referred to generically as
“derivatives” underwent significantdevelopment as they came to be used to hedge against
interest and exchange rate risks. Thisfollowed in the wake of the abandoning of the system
of fixed exchange rates and the replacement ofinterest rates by money supply as the
