It is crucial for companies to manage the risk profile of any security or transaction. This led to the design and creation of complex financial instruments to optimize the risk and reward profile. There is a range of instruments developed and in the developing stage to fulfill the demand of the market. This range is spread from financial reporting purposes to tax compliance and management planning etc. Depending on the situation and the demand, the variability in the nature and features of these instruments are quite abundant and observable. Our experts are very experienced in the valuation of all complex financial instruments used widely in the industry. We offer complete solutions for the valuation requirements from the initiation to the audit support for our clients. Some of the most widely utilized complex financial instruments include but are not limited to:
1. Contingent Consideration/Earnouts – are obligations of the buyer as a part of the purchase consideration in any acquisition which is dependent on certain events, achievements, future targets of any financial metric, etc. Considering its nature of path dependency Monte Carlo Simulation is being frequently utilized for these valuations.
2. Convertible Securities – These are the type of hybrid securities which have a unique feature to change their character depending on the business scenario and subsequently at some trigger events. Such as convertible bonds and convertible preferred shares. The primary objective of this kind of feature is to protect the downside and have a potential for upside gain.
3. Embedded Derivatives – There is a special provision in the contract of these types of instruments where the future cash flows are dependent on some other underlying metric such as interest rate, price of any commodity, the exchange rate of some foreign currency, credit rating, etc. The fair value of these derivatives is very dynamic in nature and therefore should be reported periodically in earnings.
4. Interest Rate Derivatives – These are the type of derivatives where the payoff is dependent on the underlying interest rates. These rates could be of any benchmark such as treasury yield, Interbank rates, repo rates, etc.
5. Non-Controlling Interests – All holdings of any company which is less than 50% and therefore lose the right to control, come under this ambit. The valuation of these holdings is complex in nature as the value of the right to control the business decisions has to be offset from the fair value of holdings. Control premium determination is one very subjective assessment, which plays a major role in the fair value.
6. Warrants – A warrant is basically a right to buy any particular asset such as stock, commodity, etc. at any specified price on some future date. The valuation of these rights is closely associated with the valuation of the proposed asset. Most commonly, these warrants are also utilized by the companies to lure investors as sweeteners for any new financing opportunity.
7. Structures Products – These are nonconventional securities majorly investment products where the return of the investment is linked with any underlying asset with pre-defined characteristics such as maturity date, coupon date, capital protection level, etc.
8. Equity Instruments issued as compensation – There are various instruments such as Employee stock option plans, profit interest units, and profit interest based on total shareholder returns, etc. specifically designed to be part of the compensation, to link the performance of the company with employees’ benefits and make them part of the latent upside potential of the company. Valuation of these options needs specific statistical tools to measure the performance of the company in the future with probabilistic nature.
9. Swaps – Swap refers to instruments where two parties exchange one financial instrument for another at a predetermined time as specified in the contract. These are generally aimed to hedge the risk in the future with the variable nature of instruments. Interest Rate swaps are frequently utilized to hedge currency risk.
Eton Venture Services’ complex security valuation experts understand the nuances involved within the securities as well as the peripheral market surroundings. With advanced quantitative tools and skillsets, our skilled experts can help clients in various ways such as pre-decision making stage, funding rounds with complex term structures along with meeting the criterion of financial reporting and tax implications. Contact Eton today.