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Level 1 vs Level 2 vs Level 3 Assets



There are three different ratings that a company asset can have - Level 1, Level 2 or Level 3.

Assets are classified based on the ease in which they can be valued. The value of a Level 1 asset can easily be determined because there is a clear market price and the asset is very liquid. On the other end of the spectrum, a Level 3 asset does not have a readily available quote and is usually very illiquid (tough to sell).

Let's quickly break these down:

Level 1 Asset - an asset that is traded on an active market and has a readily available price quote.

Example of Level 1 assets - US Treasuries, publicly traded stocks, ETFs (Exchange Traded Funds)

Level 2 Asset - an asset that does not have regular pricing, but in which the value can be easily determined through a simple model.

Example of Level 2 assets - interest rate swaps

Level 3 Asset - an asset that is extremely illiquid and in which the value must be "guessed". Unlike Level 1 assets, Level 3 assets do not have anything remotely resembling a price quote in an active market.

Example of Level 3 assets - stakes in private companies, complex derivatives

--

Level 3 assets were a major problem during the economic meltdown of 2007-08. Many companies had an exorbitant amount of Level 3 assets on their balance sheets and were unwilling to mark these assets down when the markets (especially the real estate market) started to implode.


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