Presented by: Ira Geraldina Nova Novita Intan Oviantari

1. The Reliability of Fair Value versus Historical Cost Information: Evidence from Closed-End Mutual Funds Presented by: Ira Geraldina Nova Novita Intan Oviantari

2. Introduction Research Questions & Theoretical Frameworks Methodology Outline Results Conclussions

3. Introduction • Opponents of fair value measurement: • Reliability problems for some fair • value estimates • Suggest that these instruments are • recognized at historical cost JWA, Basis for Conclusions: fair value more relevant than historical cost fair value represents unbiased measured (consistent within year and between enterprise) economic effect of risk is reflected in current period income Fair value is measured at market price or based on estimates (FASB) Recognizing fair value in the Balance Sheet (JWG) Subjective in estimate far value for non-traded instrument (IASC) • Proponents of fair value measurement: • Fair value valuation has more • advantages than historical cost

4. Primary Research Questions: When compared to historical measures, is the value relevance of some financial instrument (Closed-End Mutual Funds) fair values eliminated due to reliability issues relating to fair value estimation? Research Questions

5. ONA PRICE HC FV Research Questions-1

6. INC GRL FVGL Research Questions-2 RETURN

7. Research Questions-3 Reliability across fund types: • G7PUB • NG7FUB • GOV • CBONDS • OTHER • UNCLASS

8. Theoretical Framework

9. Carroll at al (2002) used closed end mutual funds which has several advantages: • Provide sufficient data to evaluate the incremental informativeness of both fair value balance sheet and income statement information • Potential problem with correlated omitted variables Is basically nonexistent • There is great variation in the securities invested in by different funds Carroll at al (2002) Vs Previous Studies • The results support the hypotheses • Solve the problem of previous studies about omitted variables • Explain that reliability problems in measuring the fair values of investment are not the primary explanation for the inconsistency in prior results

10. General Description Open-End Mutual Funds Closed-End

11. General Description • Closed-End: • Companies operate more like • a traditional companies • Shares are available only for • trade in secondary market • Subsequent purchases and sales • of shares do not effect the equity • and assets of the fund • The traded price may fluctuate in • response to supply and demand • Trade at discount/premium • Open-End: • Companies issue and redeem shares at the current market value per share • There is no secondary trading market • Equity capitalization and net assets are directly changed by magnitude of the traded share price when shares sold or redeem

12. Discount/premium has been widely studied over 30 years General Description Early explanation of discount/ premium focused on problem of measuring NAV

13. They derive from managerial performance that are not reflected in NAV (Boudreaux, 1973; Ingersoll, 1976; Chance, 1997) Discount/premium explanations Tax liability on unrealized capital appreciation does not show up in NAV (Malkiel, 1977) Liquid asset are overvalued in NAV (Malkiel, 1977) Indicate mispricing regarding individual investor sentiments cause systematic noise trading (Lee, Shleifer, Thaler, 1991) Mispricing exist in the presence of rational traders who taking full advantages of mispricing

14. Accounting Requirement

15. Accounting Requirement

16. Accounting Requirement

17. Sample selection and Descriptive Statistics

18. Descriptive statistics

19. Table 2 Data is segregated into six fund-types. Panel A presents descriptive statistics for each fund-type (S&P) Panel B list the number of funds by type for each year in our sample.

21. Empirical tests

22. Empirical tests

23. Empirical tests The Results: FV = Positive and significant HC = not significant. Use standard errors that are adjusted for heteroskedasticity and serial correlation according to Newey and west.

25. Investment Securities Fair Value Gains and Losses Reliability Test Reliability Across Fund Type

26. Investment Securities Fair Value Gains and Losses Test Using Earning Capitalization Model to determine if investor view income statement fair value security gains and losses as value relevance in a setting with no correlated omitted variables. Fair Value Income FVGL INC

27. Earning Capitalization Model Rit = γ1t + γ2 INCit + γ3 RGLit + γ4 FVGLit + εit² (3)

28. Tabel 4. Investment Securities Fair Value Gains and Losses Test Panel A Separately Yearly Regression Panel B Pooled Estimation Rit = γ1t + γ2 INCit + γ3 RGLit + γ4 FVGLit + εit² Mean R² 0,68 Mean n= 65 White’s (1980) Adjusted Standar Errors as needed Rit = γ1t + γ2 INCit + γ3 RGLit + γ4 FVGLit + εit² Mean R² = 0,67 Mean n= 971 Newey-West (1987) Adjusted Standar Errors In the close-end mutual fund setting, Carrol et al find that fair value securities gains and losses consistently provide information incremental to historical cost income measures

29. Reliability Across Fund Types Test The researcher examine the incremental informativeness of balance sheet and income statement fair value s by modifying the price and returns regressions specified previously to allow the intercept and all of the coefficient to vary across the six fund types. Rit = γ1t + γ2 INCit + γ3 RGLit + γ4 FVGLit + εit² (3) Pit = β 1t + β2t ONAit + β3t HCit + β 4t FVit + it²(2)

30. Tabel 5. Reliability Across Fund Types Test Coefficient Estimate t statistic based on Newey-West (1987) adjusted standar errors Return Regression Price Regression Rit = γ1t + γ2 INCit + γ3 RGLit + γ4 FVGLit + εit² Mean R² = 0,67 Mean n= 971 Newey-West (1987) Adjusted Standar Errors Pit = β1t + β2t ONAit + β3t HCit + β4t FVit + it² Mean R² = 0,94 Mean n= 1118

31. Reliability Across Fund Types Result Table 5 result consistent with fair value providing information incremental to Historical cost for both balance sheet and income statement information This finding is consistent with investor perceiving that the fair value estimates for equities traded in less active markets, such as private markets and markets in non G7 countries are less reliable than fair value of publicly traded equity securities from G7 countries that are traded in active markets

32. Investment securities fair values provide relevant information to close-end fund • investors : a significant association between stock price and fair value securities • gain and losses • Provide evidence consistent with close-end investors viewing fair value estimates for • G7 publicly traded equities as more reliable than those for private and non-G7 equities. • The reliability problem in measuring fair value of investment securities are not the • primary explanation for the inconsistency in prior research result, instead incomplete • availability of fair value measures in other settings. Conclusion • Suggest to standard setters : their greatest challenge in requiring the recognition of all • financial instruments at fair value may not be the reliable estimation of the fair value • of investment security assets not traded in active market. • This economic problem is virtually absent in their setting because all the net assets • of close-end mutual funds are recognized in financial statements at their fair value • or its equivalent. .