<\/span><\/h3>\n<\/p>\n
Funding fair value adjustment<\/strong> refers to the incorporation of the cost of funding into the valuation of a financial instrument. It takes into account the different rates at which an entity borrows or invests funds, reflecting market conditions and the risk associated with the transaction.<\/p>\nWhen assets and liabilities are recorded initially, the financial institution often uses its own funds for the transactions. However, it would be unrealistic to assume that these funds are available to the institution at no cost. Instead, the institution usually has to borrow or invest at market rates, which can differ based on various factors such as creditworthiness, tenor, and market conditions.<\/p>\n
To compensate for the cost of funding, financial institutions apply the funding fair value adjustment to the assets and liabilities recorded on their balance sheets. This adjustment aligns the recorded values with their fair values, considering the net present value of future cash flows using market-based funding rates.<\/p>\n