Family Finance Co. (FFC), a publicly traded commercial bank located in South Carolina, has a December 31 year-end. FFC invests in a variety of securities to enhance returns, managing its investment portfolio in an effort to earn returns greater than interest paid on bank deposits and other liabilities. As of December 31, 2020, FFCs investments primarily consist of (1) mortgage-backed securities (MBS), (2) equity securities of nonpublic companies, and (3) plain vanilla interest rate swaps that FFC uses to hedge its exposure to variable interest rates on its corporate debt. All cash payments made under these instruments are in U.S. dollars.

FFC accounts for the MBS and equity securities at fair value with changes in fair value reflected in earnings. Because FFC uses the interest rate swap in a cash-flow hedge, it measures the derivative at fair value, presenting the fair value change in OCI.

Facts related to specific securities and derivatives owned by FFC are described below.

Instrument 2 Equity Investment in a Nonpublic Company

In 2015, FFC invested in the common stock of Company X, a privately held clothing retailer that operates in a niche market of the baby clothing industry. Quoted prices are not available for Xs stock. Most of Xs competitors are either privately held or subsidiaries of larger publicly traded clothing retailers. Company X is similar to two other organizations whose shares are thinly traded in an observable market.

Note that the security does not have a readily determinable fair value and thus is eligible for the accounting alternative in ASC 321. However, FFC has not elected the alternative treatment, and thus accounts for the investment at fair value with changes in fair value recorded through earnings.

In determining an appropriate approach for measuring the fair value of its equity investment in X, FFC considered the following factors to establish whether a single or multiple valuation techniques should be adopted:

Availability and reliability of data FFC had sufficient data to support both the income and market approaches.

Comparative levels of the alternative approaches in the fair value hierarchy When using a market approach to measure the fair value of its investment in X, FFC would need to make significant entity-specific adjustments to observable market transactions (i.e., risk-adjustments for illiquidity, uncertainty of Xs future financial performance in relation to its comparables, and other adjustments to reflect business model differences between X and its comparables). Similarly, when measuring fair value using an income approach (on the basis of discounted cash flows), FFC would be required to use significant entity-specific assumptions in forecasting Xs future cash flows.

Views of market participants on the relevance of valuation techniques Through discussions with valuation specialists, FFC believes that market participants use multiple techniques (income and market approaches) to determine bid prices for similar investments. FFC also used both approaches in 2020 when pricing its investment in X.

Considering this information, in 2020 FFC determined that it would use both market and income approaches (weighted equally) to measure the fair value of its investment in X. FFC has applied a consistent approach during 2020.

Required:

Determine the appropriate classification in the fair value hierarchy for each of the instruments referenced in the case as of December 31, 2020. Provide support for your classification. Cite appropriate authoritative guidance where necessary.