NOTE 2

Cash: All cash of the University is maintained in accounts that are collateralized in accordance with the Virginia Security for Public Deposits Act, Section 2.1-359, et seq., of the Code of Virginia.

Investments: The investment policy goals, objectives, and guidelines are established by the Finance Committee of the Board. The University's cash equivalents and investments are categorized by levels of credit risk as described below:

Security Lending: Under authorization of the Board of the University of Virginia Investment Management Company, the University of Virginia, through its agent, Deutsche Bank AG New York, lends U.S. Government and equity securities to various broker-dealers on a temporary basis for collateral. All security loan agreements are collateralized by readily marketable and liquid securities, loans, or other obligations secured by a lien or similar interest on an asset, thereof totaling at least 102 percent of the market value of the loaned securities. The University of Virginia retains the right to pledge or sell these securities held as collateral at its discretion. All security loans can be terminated on demand by either the University or the borrower, and the average term of the security loans as well as collateral held is less than one week. Securities loaned as of June 30, 2001, had a carrying value of $225,105,489 and a market value of $233,106,991. Collateral received totaled $244,319,550. The value of the collateral received is 105 percent of the market value of securities loaned. As such, the University has no assumed credit risk. There were no securities on loan at June 30, 2000, except as noted below.

Additional collateral held for securities lending transactions represents the University's allocated share of cash collateral received and reinvested and securities received for the State Treasury's securities lending program. Information related to the credit risk of these investments and the State Treasury's securities lending program is available on a statewide level in the Commonwealth of Virginia's Comprehensive Annual Financial Report (CAFR).


CATEGORIZATION OF INVESTMENT RISK FOR ASSETS HELD AS OF JUNE 30, 2001 (in thousands)

Derivative Financial Instruments: Derivative instruments are financial contracts whose values depend on the values of one or more underlying assets, reference rates, or financial indexes. A derivative instrument generally has one or more underlying investment, requires little or no initial net investment, and requires or permits a net settlement. In addition, some traditional securities can have derivative-like characteristics. Examples of common derivatives include, but are not limited to, futures, forwards, options, or swap contracts. Although the contract or notional amount of the derivative is not recorded on the financial statements, all derivative instruments are recognized as either an asset or a liability depending on the rights or obligations of the contract measured at fair value.

The University has exposure, both directly and indirectly, to various derivative financial instruments that are used in the normal course of business to enhance returns on investments and manage risk exposure to changes in value due to fluctuations in market conditions. These investments may involve, to varying degrees, elements of credit and market risk in excess of amounts recognized on the financial statements. Credit risk is the possibility that losses may occur from the failure of a counterparty to perform according to the terms of the agreement. The University minimizes the credit (or repayment) risk in its direct derivative instrument by entering into transactions with high-quality counterparties and a legally enforceable master netting agreement. The "net" mark to market exposure represents the netting of the positive and negative exposures with the same counterparty. Market risk arises due to adverse changes in market price, interest rate, and foreign exchange rate fluctuations that may result in a decrease in the market value of a financial investment and/or increases, in its funding cost. The University manages market risk by establishing and monitoring limits as to the type and degree of risk that may be undertaken.

Fair Value Hedge: For the year ended June 30, 2000, the University directly entered into a fair value hedge to manage returns on a portion of its endowment investments having limited liquidity. In order to secure its obligations under the derivative instrument agreement, the University was required to retain a perfected security interest in collateral provided from the University's endowment assets. At June 30, 2001, the University was not participating in any direct fair value hedges.