Fair Value Measurement: Practical Guidance and Implementation, 2nd Edition

APPENDIX SEVEN A

Using the Guideline Transaction Method to Measure the Fair Value of a Privately Held (or Thinly Traded) Debt Security

While The Guideline Public Company and guideline transaction methods are most often used to measure an equity ownership interest, a similar market approach can be used to measure the fair value of privately held debt securities. However, instead of applying a market multiple to the subject company's earnings, a market yield is applied to the subject bond's cash flows to measure the fair value of the bond. As with any market approach method, the key to successful valuation is to identify publicly traded bonds with characteristics similar to the subject bond. A complicating factor is that public bonds generally trade much less frequently than stocks. Therefore, potentially comparable bonds must also have recent trading activity in order to serve as guideline bonds.

Guideline bonds selected for use in a market approach should have similar terms to the subject bond. One of the more important terms to consider is the maturity date. Bonds with the same maturity dates will be subject to the same capital market conditions over their lives. These market conditions are represented in the yield curve, which describes the relationship between the prevailing bond market yields and maturities. While the maturity date does not have to be identical for longer-term bonds, it should be similar. For bonds with a shorter time to maturity, guideline bonds should have ...