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FAS 133 - Embedded DerivativesFAS 141 and 142 - Impairment StudiesFAS 144 - Impairment Studies FAS 123R - Options The Financial Accounting Standards Board approved the issuance of Statement of Financial Accounting Standards 133, Implementation Issue No. B.15. FAS 133 states if a hybrid instrument contains more than one embedded derivative feature that would individually warrant separate accounting as a derivative instrument under paragraph 12, those embedded derivative features must be bundled together as a single, compounded embedded derivative instrument that would then be bifurcated and accounted for separately from the host contract. Herrera Partners has extensive experience in dealing with FAS 133 matters and has developed a comprehensive financial model that values the compound embedded derivatives utilizing a probability-weighted, discounted cash flow analysis. The embedded derivatives that have been analyzed have incorporated the following, conversion features, cash payment penalties, call/redemption options, interest rate adjustments, change of control and reset provisions. Our model has been developed to incorporate management's projections of the various potential outcomes relating to the specific features and provisions contained in the financial instrument. Typically, there are five primary events that occur regarding embedded derivatives: (i) payments are made in cash, (ii) payments are made with stock, (iii) the holder converts the note, (iv) the company redeems the note, or (v) the company defaults on the note. Based on managements estimates, Herrera Partners analyzes the underlying economic factors that can potentially influence whether the events will occur, when they were likely to occur, and the specific terms that would be in effect at the time (i.e. interest rate, stock price or conversion price). Utilizing managements estimates a projection is then made on the underlying factors which results in a series of potential scenarios. The primary factors driving the economic value of the embedded derivatives are stock price, stock volatility, trading volume, outstanding shares issued, beneficial shares owned by the holder, interest rate, whether or not a timely registration has been obtained, change in control, event of default, and the likelihood of obtaining alternative financing. Taking into consideration managements estimates, Herrera Partners assigns appropriate probabilities each of these potential scenarios over the remaining term of the underlying financial instrument. The financial model generates a monthly cash flow over the remaining life of the underlying financial instrument and assigns a risk-weighted probability to the resultant cash flow. Herrera Partners then assigns a discounted weighted average cash flow over the potential scenarios which are compared to the discounted cash flow of the note without the subject embedded derivatives. This result yields a value for the compound embedded derivatives at the point of issue and, if needed, at subsequent reporting/valuation dates. |
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