Statement of Financial Condition

UBS Securities LLC Notes to the Statement of Financial Condition (continued) (In Thousands) 6. Fair Value Measurement (continued) A critical aspect of the independent price verification process is the evaluation of the accuracy of modeling approaches and input assumptions which yield fair value estimates derived from valuation models. The output of modeling approaches is also compared to observed prices and market levels for the specific instrument being priced if possible and appropriate. This calibration analysis is performed to assess the ability of the model and its inputs (which are frequently based upon a combination of price levels of observable hedge instruments and unobservable parameters) to price a specific product in its own specific market. An independent model review group reviews the Company's valuation models on a regular basis or if specific triggers occur and approves them for valuing specific products. As a result of the valuation controls employed, valuation adjustments may be made to the business' estimates of fair value to align with independent market data. All financial instruments at fair value are categorized into one of three fair value hierarchy levels, based upon the lowest level input that is significant to the position's fair value measurement in its entirety: Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2: Valuation techniques for which all significant inputs are, or are based on, market observable data. Level 3: Valuation techniques for which significant inputs are not based on observable market data. The following is a description of the valuation techniques applied to the Company's major categories of assets and liabilities measured at fair value. U.S. Government and agency obligations U.S. Government and agency securities are generally actively traded and are valued using quoted market prices. Where market prices are not available, these securities are valued against yield curves implied from similar issuances. Mortgage-backed obligations Mortgage-backed obligations represent agency mortgage pass-through pool securities and agency collateralized mortgage obligations ("CMO's"). Pass-through pools are valued using quoted and/or traded market prices or prices on comparable securities after considering collateral characteristics, historical performance and also pricing benchmark securities. Agency CMO's are structured deals backed by specified pool collateral and are valued based on available trades, market comparable securities, and fundamental methods of valuation. Both asset classes require a view around forward interest rates, prepayments and other macro variables. 16

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