How do Level 2 inputs differ from Level 1 and Level 3?

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AcadiFi · Accepted Answer

Level 2 inputs are observable inputs other than Level 1 quoted prices. They include: (a) quoted prices for similar (not identical) assets in active markets; (b) quoted prices for identical or similar assets in markets that are not active; (c) inputs other than quoted prices that are observable (yield curves, credit spreads, implied volatility, prepayment speeds); (d) market-corroborated inputs derived from observable data. Worked example: Stratus Municipal Bond Fund holds a custom 7-year interest rate swap with Meridian Commerce Bank (notional $25M, pays 4.15% fixed, receives SOFR + 45bps). No identical swap trades on any exchange. But the fund values it using observable SOFR curve, observable 7-year Treasury yield, and observable CDS spread on Meridian (78 bps). Combining these observable market inputs into a discounted cash flow produces a $1.42M fair value — this is Level 2. ```mermaid graph TD A[Fair Value Input] --> B{Quoted price
identical asset
active market?} B -->|Yes| C[Level 1] B -->|No| D{Observable
inputs available?} D -->|Yes| E[Level 2] D -->|No| F[Level 3] ``` Compare to Level 3: if Stratus held a bespoke weather derivative tied to Iowa rainfall where no observable volatility surface exists, it drops to Level 3. Compare to Level 1: if the swap were a listed exchange-traded future, it would be Level 1. Key tested distinction: corporate bonds priced by a pricing service using matrix pricing (yields on comparable credits) are Level 2, even though the bond trades OTC.

How do Level 2 inputs differ from Level 1 and Level 3?

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