2007 REGISTRATION DOCUMENT

5 NotesCONSOLIDATED FINANCIAL STATEMENTSto the financial s tatements p repared in accordance with I nternational Financial Reporting S tandards as adopted by the European Union< Contents >The Bank distinguishes between three categories of financial instrumentsbased on the characteristics of the instrument and the measurementmethod used. This classification is used as the basis for the informationprovided in the notes to the consolidated financial statements inaccordance with international accounting standards:■ category 1: financial instruments quoted on an active market;■ category 2: financial instruments measured using valuation modelsbased on observable parameters;■ category 3: financial instruments measured using valuation modelsbased wholly or partly on non-observable parameters. A nonobservableparameter is defined as a parameter whose value resultsfrom assumptions or correlations which are not based on observablecurrent market transactions in the same instrument at the valuationdate, or on observable market data at that date.Instruments traded in active marketsIf quoted prices in an active market are available, they are used todetermine fair value. This method is used for quoted securities and forderivatives traded on organised markets such as futures and options.The majority of over-the-counter derivatives, swaps, forward rateagreements, caps, floors and standard options are traded in activemarkets. Valuations are determined using generally accepted models(discounted cash flows, Black-Scholes model, interpolation techniques)based on quoted market prices for similar instruments or underlyings.The valuation derived from these models is adjusted for liquidity andcredit risk.Starting from valuations derived from median market prices, priceadjustments are used to value the net position in each financialinstrument at bid price in the case of short positions, or at asking pricein the case of long positions. Bid price is the price at which a counterpartywould buy the instrument, and asking price is the price at which a sellerwould sell the same instrument.A counterparty risk adjustment is included in the valuation derivedfrom the model in order to reflect the credit quality of the derivativeinstrument.Instruments traded in inactive marketsProducts traded in inactive markets and valued using aninternal valuation model based on directly observableparameters or on parameters derived from observable dataSome financial instruments, although not traded in an active market,are valued using methods based on observable market data.These models use market parameters calibrated on the basis of observabledata such as yield curves, implicit volatility layers of options, default rates,and loss assumptions obtained from consensus data or from active overthe-countermarkets. Valuations derived from these models are adjustedfor liquidity, credit and model risk.The margin generated when these financial instruments are traded istaken to the profit and loss account immediately.Products traded in inactive markets and valued using aninternal valuation model based on parameters that are notobservable or only partially observableSome complex financial instruments, which are usually tailored, illiquidor have long maturities, are valued using internally-developed techniquesand techniques that are based on data only partially observable on activemarkets.In the absence of observable data, these instruments are measured oninitial recognition in a way that reflects the transaction price, regardedas the best indication of fair value. Valuations derived from these modelsare adjusted for liquidity risk and credit risk.The margin generated when these complex financial instruments aretraded (day one profit) is deferred and taken to the profit and lossaccount over the period during which the valuation parameters areexpected to remain non-observable. When parameters that wereoriginally non-observable become observable, or when the valuationcan be substantiated by comparison with recent similar transactionsin an active market, the unrecognised portion of the day one profit isreleased to the profit and loss account.Unlisted equity securitiesThe fair value of unquoted equity securities is measured by comparisonwith recent transactions in the equity of the company in question carriedout with an independent third party on an arm’s length basis. If nosuch reference is available, the valuation is determined either on thebasis of generally accepted practices (EBIT or EBITDA multiples) or ofthe Group’s share of net assets as calculated using the most recentlyavailable information.1.c.10 Financial a ssets and l iabilitiesd esignated at f air v alue t hrough p rofitor l oss (f air v alue o ption)The amendment to IAS 39 relating to the “fair value option” wasadopted by the European Union on 15 November 2005, with effectfrom 1 January 2005.This option allows entities to designate any financial asset or financialliability on initial recognition as measured at fair value, with changes infair value recognised in profit or loss, in the following cases:■ hybrid financial instruments containing one or more embeddedderivatives which otherwise would have been extracted and accountedfor separately;■ where using the option enables the entity to eliminate or significantlyreduce a mismatch in the measurement and accounting treatmentof assets and liabilities that would arise if they were to be classifiedin separate categories;■ where a group of financial assets and/or financial liabilities is managedand measured on the basis of fair value, under a properly documentedmanagement and investment strategy.BNP Paribas applies this option primarily to financial assets related tounit-linked business (in order to achieve consistency of treatment withthe related liabilities), and to structured issues containing significantembedded derivatives.12345678910111222007 Registration document - BNP PARIBAS