PSH-Annual-Report

Annual Report December 31, 2014Notes to Financial Statements (continued)7. FAIR VALUE OF ASSETS AND LIABILITIES (continued)Sensitivity Analysis to Significant Changes in Unobservable Inputs with Level 3 HierarchyThe significant unobservable inputs used in the fair value measurement categorized within Level 3 of thefair value hierarchy together with a quantitative sensitivity analysis are shown as follows:FinancialAssetYearEndedUnobservableInput Sensitivity Used *Effect onFair ValueWarrants 2014 Volatility +2 $ 261,974Warrants 2014 Volatility -2 $ (235,963)Warrants 2013 Volatility +2 $ 397,046Warrants 2013 Volatility -2 $ (169,630)*The sensitivity analysis refers to the volatility unit added and deducted from the input and the effect thishas on the fair value.8. DERIVATIVE CONTRACTSIn the normal course of business, the Companyenters into derivative contracts for investmentpurposes. Typically, derivative contracts serve ascomponents of the Company’s investmentstrategies and are utilized primarily to structure theportfolio to economically match the investmentobjectives of the Company. These instruments aresubject to various risks, similar to non-derivativeinstruments, including market, credit and liquidityrisk (see Note 13). The Company manages theserisks on an aggregate basis along with the risksassociated with its investing activities as part of itsoverall risk management policy.The Company’s derivative trading activities areprimarily the purchase and sale of OTC and listedoptions, equity forwards, credit default swaps andinvestment grade index tranche swap contractsalong with total return swap contracts and foreigncurrency forward contracts. All derivatives arereported at fair value (as described in Note 2) inthe statement of financial position. Changes in fairvalue are reflected in the statement ofcomprehensive income.Total Return SwapsTotal return swap contracts represent agreementsbetween two parties to make payments basedupon the performance of a certain underlyingasset. The Company is obligated to pay or entitledto receive as the case may be, the net difference inthe value determined at the onset of the swapversus the value determined at the termination orreset date of the swap. The amounts required forthe future satisfaction of the swaps may be greateror less than the amounts recorded in the statementof financial position. The ultimate gain or lossdepends upon the prices of the underlying financialinstruments on settlement date.Credit Default SwapsA credit default swap contract represents anagreement that one party, the protection buyer,pays a fixed fee, the premium, in return for apayment by the other party, the protection seller,contingent upon a specified credit event relating toan underlying reference asset. While there is nocredit event, the protection buyer pays theprotection seller a quarterly fixed premium. If aspecified credit event occurs, there is an exchangeof cash flows and/or securities designed so that thenet payment to the protection buyer reflects theloss incurred by holders of the referencedobligation in the event of its default. TheInternational Swaps and Derivatives Association(“ISDA”) establishes the nature of the credit eventand such events include bankruptcy and failure tomeet payment obligations when due.OptionsOptions are contractual agreements that conveythe right, but not the obligation, for the purchasereither to buy or sell a specific amount of a financialinstrument at a fixed price, either at a fixed futuredate or at any time within a specified period.PERSHING SQUARE HOLDINGS, LTD. 55