# Understanding Level 2 Assets: Key Examples and Differences from Levels 1 & 3

![An investor looking at their investment portfolio holdings to see their current value](https://www.investopedia.com/thmb/cj4FGTJH-2yEUBofLmlkmmiiMGo=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/TopHoldings-d27749258de94fc9be579220b10ab2f8.jpg)

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> **Definition**
>
> Level 2 assets are financial instruments that lack direct market pricing and are valued using observable market data or models, falling in the middle tier of the fair value hierarchy under accounting standards.

## What Is a Level 2 Asset?

Level 2 assets are financial assets valued using market price data from similar items rather than direct quoted prices. This makes them less transparent than Level 1 assets but more reliable than Level 3. These assets are commonly held by institutions like private equity firms and insurance companies, and are valued using external data, such as interest rates and yield curves. Investors should understand the differences between these assets because they can judge a company’s financial reporting risk and transparency. Knowing how Level 2 assets work can give investors insight into a company’s financial health so they can make smarter investment decisions.

### Key Takeaways

*   Level 2 assets lack regular market pricing but are valued using observable data or prices of similar assets.  
    
*   They are often held by investment institutions like private equity firms and insurance companies.  
    
*   According to GAAP, assets must be recorded at current values, not historical costs, for accurate valuation.  
    
*   Level 2 assets include corporate bonds, loans, and derivatives valued using inputs like interest rates and risk premiums.  
    
*   The distinction between Level 2 and Level 3 assets depends on the public availability of market data used for valuation.

## How to Analyze Level 2 Assets  

Publicly traded companies must set fair values for their assets. Investors use these values to assess the firm's condition and its future prospects.

Under [GAAP](https://www.investopedia.com/terms/g/gaap.asp) some assets must be recorded at their current value rather than their historical cost. Publicly traded companies must also classify all their assets based on the ease with which they can be valued in compliance with the accounting standard Financial Accounting Standards Board [(FASB) 157](https://www.investopedia.com/terms/f/fasb_157.asp). 

The FASB introduced three asset levels to clarify corporate balance sheets. Level 2 assets are the middle classification based on how reliably their fair market value can be calculated. [Level 1 assets](https://www.investopedia.com/terms/l/level1_assets.asp) such as stocks and bonds are the easiest to value. [Level 3 assets](https://www.investopedia.com/terms/l/level3_assets.asp) can only be valued based on internal models or "guesstimates." They have no observable market prices.

> **Fast Fact**
>
> Level 2 assets are commonly held by private equity firms, insurance companies, and other financial institutions that have investment arms. 

Level 2 assets are valued using market data from independent sources, including quoted prices in active and inactive markets or models with observable inputs. These include default rates, interest rates, and yield curves.

An [interest rate swap](https://www.investopedia.com/terms/i/interestrateswap.asp), a Level 2 asset, is valued based on observed interest rates and market-determined [risk premiums](https://www.investopedia.com/terms/r/riskpremium.asp)

## Real-World Examples of Level 2 Assets

Blackstone Inc. breaks down its Level 2 assets in the firm's 10-K and 10-Q filings for shareholders. The asset manager disclosed the following information in the filings:

"Fair value is determined through the use of models or other valuation methodologies. Financial instruments that are generally included in this category include corporate bonds and loans, including corporate bonds and loans held within [CLO](https://www.investopedia.com/terms/c/clo.asp) vehicles, government and agency securities, less liquid and restricted equity securities, and certain over-the-counter derivatives where the fair value is based on observable inputs. Senior and subordinated notes issued by CLO vehicles are classified within Level II of the fair value hierarchy."

## Differentiating Between Observable and Unobservable Inputs

Investors and analysts often struggle to differentiate Level 2 and Level 3 assets, but it's crucial because GAAP mandates more disclosures for Level 3 assets. Whether an asset or liability is Level 2 or Level 3 is dependent on the valuation inputs and whether the market data that's used is available to the public.

This brings a few questions to the forefront:

*   Is the value supported by real market transactions?
*   Is a price obtained from outside the organization and is it readily available to the public?
*   Is the valuation distributed at regular intervals?

The input may be considered unobservable if the answer to any of these questions is no. Level 3 is the fair value hierarchy as a result.

## What Is an Interest Rate Swap?

An interest rate swap occurs when two parties exchange interest payments to be made at a future point in time. Swaps are typically made over the counter, not on exchanges. They're based on the principal value of the underlying assets. They commonly come into play between loans with floating and fixed rates.

## What Is Fair Market Value?

The Cornell Law School Legal Information Institute defines fair market value as "the value of property as determined by the marketplace (or objective purchasers) rather than as determined by a subjective individual. This is what an informed and unpressured buyer would pay to an informed, unpressured seller in an arm's length transaction."

## What Is GAAP?

GAAP (generally accepted accounting principles) was jointly created and issued by the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB). It sets accounting rules and standards that can be used across industries so financial information can be more easily compared and exchanged.

## The Bottom Line

Level 2 assets are financial assets commonly found in the portfolios of private equity firms and insurance companies. They are valued using observable data from similar items, which makes them less transparent than Level 1 assets but more reliable than Level 3 assets. Investors can use Level 2 assets to help them evaluate a company's financial statements and investment opportunities so they can assess its financial health and any associated risks.

> **Article Sources**
>
> 1.  U.S. Securities and Exchange Commission. "[Blackstone Inc. Form 10-Q for the Period Ended March 31, 2024](https://d18rn0p25nwr6d.cloudfront.net/CIK-0001393818/5d6f6a4d-396e-4855-aedd-73d45ba5bd89.pdf)," Page 18.
>     
> 2.  U.S. Securities and Exchange Commission. "[Significant Accounting Policies](https://www.sec.gov/Archives/edgar/data/1364742/000119312512460708/R11.htm)."