QUESTION 27 Illustration 17: Written option with multiple exercise prices WC Limited writes an option in favour of GT Limited wherein the holder can purchase issuer’s equity instruments at prices that fluctuate in response to the share price of issuer. As per the terms, if the share price of issuer is less than $ 50 per share, option can be exercised at $ 40 per share. If the share price is equal to or more than $ 50 per share, option can be exercised at $ 60 per share. Explain the nature of the financial instrument.

Solution

The financial instrument in this scenario is a derivative that contains a written option component, and the issuer, WC Limited, will classify it as a financial liability. T

he option has two different exercise prices depending on the underlying equity instrument's price, making it a compound option. The fair value of this derivative instrument depends on the stock price of the underlying shares, which means it is subject to market risk.

The issuer will measure the financial liability at fair value at each reporting date, with changes in the fair value recognized in profit or loss.

Additionally, if the fair value of the option decreases over time, the issuer will recognize a gain in profit or loss, and if the fair value increases, a loss will be recognized. Therefore, this derivative instrument will be measured at fair value through profit or loss.

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