Case Study – Financial Instruments for Financial Reporting

CFO of a publicly listed, microcap company engaged InteleK to establish a fair value of a large tranche of newly issued warrants under IFRS 13 (Fair Value Measurement) for financial reporting purposes.
Timely and accurate delivery was key in order to deliver the results to the auditor to avoid delays for a year end review.
The original appraisal proposal to the CFO by another firm was to apply the Black-Scholes option pricing method, which relies on the assumption of a normal distribution with symmetric event probabilities and very rare extreme events.
We identified that as a microcap stock with empirically verifiable, non-symmetric event probabilities and regular extreme events, application of the Black-Scholes method was inappropriate and would likely result in a significant mis-statement of warrants value. Moreover, IFRS 13 places the highest priority on the use of observable, market inputs such as historical stock prices to minimize model risk – the Black – Scholes method would not be satisfying these requirements.
We developed a custom, non-linear Monte Carlo simulation with a custom cost of capital estimate to estimate the present value of expected payoffs during the exercise period based on thousands of simulated scenarios of potential stock price behavior consistent with the stock’s historical characteristics.
Fair Value of warrants derived from our custom methodology was over 4 times lower as compared to the Black-Scholes estimates.