Complex Financial Instruments - In Depth Flashcards
Convertible debt - Definition
A compound instrument that
includes:
- Debt: bond pays interest at
specified rate and pays face
amount at maturity. - Equity: option to exchange
bond for common shares;
usually a predetermined
number, during a specified
time frame, without the
need to pay additional cash.
Convertible debt - Initial measurement
- Debt: fair value using
the market interest rate
for similar debt with
no conversion right —
deduct pro-rata share of
transaction costs. - Equity (contributed
surplus): residual amount
— deduct pro-rata share
of transaction costs.
Convertible debt - Subsequent measurement
If not converted:
1. Debt — amortized cost
2. Equity — historical cost
If converted:
1. Update for interim interest
expense up to derecognition
date.
2. Derecognize the debt and
equity components.
3. Record the issuance of the
common shares equal to the
sum of the amounts debited to
debt and contributed surplus.
4. No gain or loss is recognized.
Perpetual debt - Definition
An instrument where there is
a contractual right to receive
payments of interest at fixed
dates into the indefinite future,
either with no right to receive a
return of principal or a right to a
return of principal under terms
that make it unlikely.
Perpetual debt - Initial measurement
Fair value equal to present
value of the perpetuity of
interest payments.
Perpetual debt - Subsequent measurement
Amortized cost
Convertible preferred shares - Definition
Preferred shares that have the
option to convert into common
shares. Both components are
equity.
Convertible preferred shares - Initial measurement
Recognize as equity at fair
value of the consideration
received.
Convertible preferred shares - Subsequent measurement
If not converted: historical cost
If converted:
- Derecognize the preferred
shares. - Record issuance of common
shares: debit to preferred
shares and credit to common
shares for the same amount. - No gain or loss is recognized.
Mandatorily redeemable or retractable preferred shares - Definition
Mandatorily redeemable: issuer
must redeem the shares on or
before a specified date for a fixed
or determinable amount.
Retractable: holder has the right
to force the entity to redeem
the shares by providing cash or
another asset.
Mandatorily redeemable or retractable preferred shares - Initial measurement
Record as a liability
at fair value of the
consideration received
when shares have a
mandatory redemption
or are retractable.
Mandatorily redeemable or retractable preferred shares - Subsequent measurement
- Subsequently measured at
amortized cost using the
effective interest rate method. - Related dividends are
recorded as interest expense.
Warrants - Definition
Contracts that entitle the holder
to buy or sell the underlying
stock of the issuing entity at a
fixed price until the expiry date.
Can be issued attached to both
bonds and shares.
Warrants - Initial measurement
- Bonds with warrants:
issue proceeds
are allocated
proportionately based
on fair values (bonds
measured at fair value
using the market interest
rate for similar debt;
warrants using fair value
shortly after issuance
or an options pricing
model); deduct pro-rata
share of transaction
costs. - Shares with warrants:
issue proceeds
are allocated
proportionately based
on fair values (shares
based on market prices;
warrants using fair value
shortly after issuance
or an options pricing
model); deduct pro-rata
share of transaction
costs.
Warrants - Subsequent measurement
Bond or shares:
1. Debt — amortized cost
2. Shares — not subsequently
remeasured
Warrants: carrying value
If exercised:
1. Record the cash received.
2. Derecognize the equity
element (contributed surplus).
3. Record the issuance of the
common shares equal to the
sum of the amounts debited
to cash and contributed
surplus.
No gain or loss is recognized.