Sprint - Nextel 2011 Annual Report Download - page 129

Table of Contents
CLEARWIRE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
upon the issuance of the Exchangeable Notes, we recognized Exchange Options with an estimated fair value of $231.5 million as a derivative liability. The Exchange
Options are indexed to Class A Common Stock, have a notional amount of 103.0 million shares and mature in 2040. We do not apply hedge accounting to the Exchange
Options. Therefore, gains and losses due to changes in fair value are reported in our consolidated statements of operations. At December 31, 2011 and 2010, the Exchange
Options’ estimated fair value of $8.2 million and $167.9 million, respectively, was reported in Other current liabilities on our consolidated balance sheets. For the years
ended December 31, 2011 and 2010, we recognized gains of $159.7 million and $63.6 million, respectively, from the changes in the estimated fair value in Gains (loss) on
derivative instruments in our consolidated statements of operations. See Note 12, Fair Value, for information regarding valuation of the Exchange Options.
In addition, in the event of an issuance of New Securities, certain existing equityholders are entitled to the pre-emptive rights which allow them to purchase their
pro-rata share of the New Securities at the issuance price less any underwriting discounts. This right is considered a derivative that is required to be recorded at fair value
and has a payment provision based on the existing equityholders' pro-rata ownership interest in Clearwire. We do not apply hedge accounting to this derivative. A portion
of the derivative was settled on December 13, 2011 with the issuance of Class B Common Stock and Class B Common Interests to Sprint and we recorded a charge of
$15.9 million for the year ended December 31, 2011 in Gains (loss) on derivative instruments in our consolidated statements of operations representing the value of the
derivative. See Note 15, Stockholders' Equity, for more information on the recent Sprint transaction. The fair value of this derivative is determined by, among other
things, the probability of a New Securities issuance, the probability that existing equityholders will participate in any new issuance and the extent of their participation, if
any.
During 2009, we had two interest rate swap contracts which were based on 3-month LIBOR with a combined notional of $600.0 million. We used these swaps as
economic hedges of the interest rate risk related to a portion of our LIBOR based long-term debt. We were not holding these interest rate swap contracts for trading or
speculative purposes and we did not apply hedge accounting to these swaps. During the fourth quarter of 2009, we terminated the swap contracts. For the year ended
December 31, 2009, we recognized a net loss of $7.0 million in Gains (loss) on derivative instruments in our consolidated statements of operations due to changes in fair
value.
The following is a description of the valuation methodologies and pricing assumptions we used for financial instruments measured and recorded at fair value on a
recurring basis in our financial statements and the classification of such instruments pursuant to the valuation hierarchy.
Cash Equivalents and Investments
Where quoted prices for identical securities are available in an active market, we use quoted market prices to determine the fair value of investment securities and
cash equivalents, and they are classified in Level 1 of the valuation hierarchy. Level 1 securities include U.S. Government and Agency Issues and money market mutual
funds for which there are quoted prices in active markets.
For other debt securities which are classified in Level 3, we use discounted cash flow models to estimate the fair value using various methods including the market
and income approaches. In developing these models, we utilize certain assumptions that market participants would use in pricing the investment, including assumptions
about risk and the risks inherent in the inputs to the valuation technique. We maximize the use of observable inputs in the pricing models where quoted market prices from
securities and derivatives exchanges are available and reliable. We also use certain unobservable inputs that cannot be validated by reference to a readily observable
market or exchange data and rely, to a certain extent, on management’s own assumptions about the assumptions that market participants would use in pricing the security.
We use many factors that are necessary to estimate market values, including interest rates, market risks, market spreads, timing of contractual cash flows, market liquidity,
review of underlying collateral and principal, interest and dividend payments.
D
erivatives
The Exchange Options are classified in Level 3 of the valuation hierarchy. To estimate the fair value of the Exchange Options, we use an income approach based on
valuation models, including option pricing models and discounted cash flow models. We maximize the use of market-based observable inputs in the models and develop
our own assumptions for unobservable inputs based on management estimates of market participants’ assumptions in pricing the instruments.
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12. Fair Value