From the A-Z Guide: Broker quote

Broker quote: A determination of a security’s value provided by a third party, typically by either a valuation firm or a broker/dealer. Typically more relevant for debt securities than for equity. When using broker quotes to assign value to securities, the holder must take appropriate steps to understand the basis on which the quote was prepared, such as a quote from an active market, a quote from private bid/ask spreads or a quote based on a proprietary pricing model.

The owner of securities valued through brokers must understand the source data for the quote in order to determine whether the quote is compliant with accounting standards. Duff & Phelps

Broker quotes have been increasingly scrutinised to a high degree, both by auditors and internal managers. The owner of securities valued through brokers must understand the source data for the quote in order to determine whether the quote is compliant with accounting standards. Broker quotes are typically used in conjunction with other valuation processes to determine fair value. However, there may be instances where a broker quote is used as the only data source for estimating fair value. While it is less common to use broker quotes as the only input in estimating fair value, when such quotes are the only input source used, the owner of the investment will typically apply a range of quotes that are obtained either from the same source or from a number of sources that cover the security.

One of the more important facets of using broker quotes is the determination of an active or inactive market. According to FASB ASC 820-10-65 (formerly FSP SFAS 157-4), factors indicative of when a market becomes less active are:

• • There are few recent transactions.
• • Price quotations are not based on current information.
• • Price quotations vary substantially either over time or among market makers (for example, some brokered markets).
• • Indexes that were previously highly correlated with the fair values of the asset or liability are demonstrably uncorrelated with recent indications of fair value for that asset or liability.
• • There is a significant increase in implied liquidity risk premiums, yields or performance indicators (such as delinquency rates or loss severities) for observed transactions or quoted prices when compared with the reporting entity’s estimate of expected cash flows, considering all available market data about credit and other non-performance risk for the asset or liability.
• • There is a wide bid/ask spread or significant increase in the bid/ask spread.
• • There is a significant decline or absence of a market for new issuances (that is, a primary market) for the asset or liability or similar assets or liabilities.
• • Little information is released publicly (for example, a principal-to-principal market).

FASB ASC 820-10-65 also defines an orderly transaction as “a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction.” Significant judgment must be undertaken when assigning fair value to securities based on broker quotes. Additionally, a number of factors must be considered in order to determine whether the quote was produced in accordance with regulations.

This is only one of over 70 of the most common applications of fair value explained in The Definitive Guide to Private Equity Valuation: An in-depth A-Z guide to valuing investments fairly, a new book from PEI Media. Primarily written by valuation experts Duff & Phelps LLC, this guide provides investors and fund managers with valuable tools and practical guides to fairly value nuances and scenarios, as well as case studies and best practices. Sample contents and more information on the book are available here.