Question 2 10 Marks Black Ltd enters into a call option contract with White Ltd that gives Black Ltd the right to acquire 100,000 shares in Orange Ltd. The options premium is $0.50 each. The details of the options contract are: Contract date Settlement terms Exercise date (only at maturity) Exercise right holder Exercise price per share Share price at maturity Number of shares under option contract Fair value of option contract on 1 February 2018 Fair value of option contract on 30 June 2018 Fair value of option contract on 31 July 2018 1 February 2018 Net cash settlement 31 July 2018 Black Ltd $1.50 $1.70 100,000 $50,000 $30,000 $20,000 Required (a) Explain why the call option contract satisfies the definition of a financial instrument in AASB 9 Financial Instruments. Is it a primary or derivative financial instrument? (3 marks) (b) Explain how Black Ltd would measure the call option contract (1) on initial recognition and (2) subsequent to initial recognition. Justify your answer. (2 marks) (c) Prepare the journal entries for Black Ltd as the call option holder. (5 marks) Question 2 10 Marks On 1 July 2018, Foy Ltd issues 600 convertible notes. The notes have a three-year term and are issued at par with a face value of $1,000 per note, giving total proceeds at the date of issue of $600,000. The notes pay interest at 5% per annum in arrears. The holder of each note is entitled to convert the note into 200 ordinary shares of Foy Ltd at contract maturity. The convertible notes are not held by Foy Ltd for trading and, because they do not satisfy the criteria in AASB 9 Financial Instruments, cannot be measured at fair value through profit or loss. When the notes were issued, the prevailing market interest rate for similar debt (similar term, similar credit status of issuer and similar cash flows) without conversion options is 9% per annum. The following are the relevant present value interest factors (PVIF): PVIF for $1 for 3 years at 9% is 0.772183. PVIF for an annuity of $1 for 3 years at 9% is 2.5313. Required (a) Explain how Foy Ltd would measure the convertible notes (1) on initial recognition and (2) subsequent to initial recognition. Justify your answer. (2 marks) (b) Prepare the journal entries for Foy Ltd assuming the holders of the notes do not exercise their option to convert the notes into shares and the note is repaid at the end of its term. (7 marks) (c) Explain how your answer to (b) above would change if the holders exercise their conversion option at the expiration of the contract term. (1 mark) Question 2 10 Marks Black Ltd enters into a call option contract with White Ltd that gives Black Ltd the right to acquire 100,000 shares in Orange Ltd. The options premium is $0.50 each. The details of the options contract are: Contract date Settlement terms Exercise date (only at maturity) Exercise right holder Exercise price per share Share price at maturity Number of shares under option contract Fair value of option contract on 1 February 2018 Fair value of option contract on 30 June 2018 Fair value of option contract on 31 July 2018 1 February 2018 Net cash settlement 31 July 2018 Black Ltd $1.50 $1.70 100,000 $50,000 $30,000 $20,000 Required (a) Explain why the call option contract satisfies the definition of a financial instrument in AASB 9 Financial Instruments. Is it a primary or derivative financial instrument? (3 marks) (b) Explain how Black Ltd would measure the call option contract (1) on initial recognition and (2) subsequent to initial recognition. Justify your answer. (2 marks) (c) Prepare the journal entries for Black Ltd as the call option holder. (5 marks) Question 2 10 Marks On 1 July 2018, Foy Ltd issues 600 convertible notes. The notes have a three-year term and are issued at par with a face value of $1,000 per note, giving total proceeds at the date of issue of $600,000. The notes pay interest at 5% per annum in arrears. The holder of each note is entitled to convert the note into 200 ordinary shares of Foy Ltd at contract maturity. The convertible notes are not held by Foy Ltd for trading and, because they do not satisfy the criteria in AASB 9 Financial Instruments, cannot be measured at fair value through profit or loss. When the notes were issued, the prevailing market interest rate for similar debt (similar term, similar credit status of issuer and similar cash flows) without conversion options is 9% per annum. The following are the relevant present value interest factors (PVIF): PVIF for $1 for 3 years at 9% is 0.772183. PVIF for an annuity of $1 for 3 years at 9% is 2.5313. Required (a) Explain how Foy Ltd would measure the convertible notes (1) on initial recognition and (2) subsequent to initial recognition. Justify your answer. (2 marks) (b) Prepare the journal entries for Foy Ltd assuming the holders of the notes do not exercise their option to convert the notes into shares and the note is repaid at the end of its term. (7 marks) (c) Explain how your answer to (b) above would change if the holders exercise their conversion option at the expiration of the contract term. (1 mark)
