The world of finance can be complex and confusing, especially when it comes to investment contracts. One particular type, the guaranteed investment contract (GIC), is often used in retirement plans and other long-term investments. When valuing these contracts, a fair value hierarchy is used to determine their worth.
The fair value hierarchy is a set of guidelines established by accounting standards to ensure consistent and accurate valuation of financial assets. There are three levels to the hierarchy: Level 1, Level 2, and Level 3.
Level 1 assets are those that have a readily available market value, such as publicly traded stocks or bonds. These assets are usually valued using market prices, and their value is generally considered to be reliable.
Level 2 assets are those that do not have a readily available market value, but can still be valued using observable inputs. This includes things like private equity investments or real estate. While these assets may be harder to value, there are still observable data points that can be used to estimate their worth.
Level 3 assets are those that do not have any observable market data and must be valued using unobservable inputs, such as a GIC. The fair value of these assets must be based on assumptions and estimates, and are subject to more scrutiny than Level 1 or Level 2 assets.
When valuing a GIC, the fair value hierarchy requires that all observable data be used to establish its worth, including the issuer`s credit rating, the interest rate environment, and market conditions. If these factors cannot fully determine the value, then unobservable inputs must be used to estimate the GIC`s fair value.
It`s important for investors and financial professionals to understand the fair value hierarchy when valuing GICs and other financial assets. Through this process, a more accurate and consistent valuation of these investments can be achieved, leading to better decision making and more successful long-term investments.