Fair Value Measurement
Since the net capital calculation depends so heavily on knowing the current value of the firm's assets, rules have been developed for how to determine the fair value of those assets. Some methods of fair value measurement are more reliable and accurate than others, and regulators expect firms to use the best method available to measure the fair value for a given asset. But how can a firm demonstrate that it is using the best available method? This is an important question, because calculating net capital incorrectly could lead to a firm being found in violation of SEC rules.
To give firms some clarity about which methods of measuring fair value should be used for a given asset, the Financial Accounting Standards Board (FASB) developed the fair value hierarchy. The hierarchy consists of three levels. If it is possible to use a method from Level 1, the firm must do so. If not, the firm may use a method from Level 2. At the bottom of the hierarchy is Level 3, consisting of methods that may only be used if no other methods are available.
Level 1. The quoted price of the asset in an active market, such as an exchange-listed securit
