Bradken Limited Annual Report 2015 - page 80

45 l BRADKEN LIMITED ANNUAL REPORT 2015
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Notes to the consolidated financial statements
30 June 2015
(continued)
3 Financial risk management (continued)
Asset Volatility
Asset Default Threshold
A description of the valuation process for the conversion option associated with the redeemable preference shares is
summarised below. The estimation of the fair value of the conversion option requires judgement with respect to the appropriate
valuation methodology. To value the conversion option a binomial tree lattice methodology has been used which is underpinned
by a theoretical 'risk neutral' probability framework and the assumption of a lognormal distribution for asset values. This
methodology and involves the following steps:
50%
$35,000,000
Level 3 Financial Instruments
For the purposes of identifying transactions which are required to be categorised as level 3, the group applies judgement to
assess both the observability of input to the valuation technique applied, and the significance of the input to the overall valuation
of the transaction. The redeemable preference shares conversion option is recognised as level 3 financial instrument, due to the
presence of significant unobservable inputs used in the binomial tree lattice valuation methodology. The significant unobservable
inputs are as follows:
The following table presents the group’s assets and liabilities measured and recognised at fair value at 30 June 2015 and 30
June 2014.
1. Propagate the asset value of the company through a binomial tree lattice methodology.
2. Calculate the payoff of the conversion option and RPS at maturity and other key dates of the RPS.
3. Probability weight and discount all potential conversion option values back to the valuation date.
The value of the conversion option is sensitive to both changes in volatility and asset default threshold assumptions. The asset
volatility assumption is representative of the level of uncertainty expected in the movements in the value of the company’s assets
over the life of the RPS. The asset default threshold plus the face value of the RPS represents the level whereby the payout of
the RPS is reduced representing the instances where value is lost as an organisation ceases to be a going concern.
A volatility of 40% would result in a conversion option value of $2.6m (decrease of $1.6m) and a volatility of 60% would result in a
conversion option value of $6.1m (increase of $1.9m).
An asset default threshold of nil will result in a conversion option value of $5.1m (increase of $0.9m) and an asset default
threshold of $70m would result in a conversion option value of $3.4m (decrease of $0.8m).
- - 4,200 4,200
Assets
Derivatives used for hedging
-
The fair value of financial instruments traded in active markets (such as publicly traded derivatives, and trading and available-for-
sale securities) is based on quoted market prices at the end of the reporting period. The quoted market price used for financial
assets held by the group is the current bid price. These instruments are included in level 1.
The fair value of financial instruments that are not traded in an active market (for example, over-the-counter derivatives) is
determined using valuation techniques. The group uses a variety of methods and makes assumptions that are based on market
conditions existing at the end of each reporting period. Quoted market prices or dealer quotes for similar instruments are used to
estimate fair value for long-term debt for disclosure purposes. Other techniques, such as estimated discounted cash flows, are
used to determine fair value for the remaining financial instruments. The fair value of interest rate swaps is calculated as the
present value of the estimated future cash flows. The fair value of forward exchange contracts is determined using forward
exchange market rates at the end of the reporting period. The fair value of the redeemable preference shares is determined using
the binomial tree lattice methodology. In the circumstances where a valuation technique for these instruments is based on
significant unobservable inputs, such instruments are included in level 3.
Total
$'000
Level 3
$'000
Level 2
$'000
Level 1
$'000
2015
Assets
Derivatives used for hedging
Total assets
Liabilities
Derivatives used for hedging
Total liabilities
- 1,356 - 1,356
- 1,332 - 1,332
1,332
- 1,332 -
Redemable preference shares - option
- - -
Total assets
- - - -
2014
Level 1
$'000
Level 2
$'000
Level 3
$'000
Total
$'000
- 1,356 4,200 5,556
Total liabilities
- 2,809 - 2,809
Liabilities
Derivatives used for hedging
- 2,809 - 2,809
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Bradken Limited
1...,70,71,72,73,74,75,76,77,78,79 81,82,83,84,85,86,87,88,89,90,...131
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