Sprint - Nextel 2013 Annual Report Download - page 196

Table of Contents
Index to Consolidated Financial Statements
CLEARWIRE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — ( CONTINUED)
The holders
’ exchange rights contained in the Exchangeable Notes constitute embedded derivative instruments that are required to be accounted for
separately from the debt host instrument at fair value. As a result, upon the issuance of the Exchangeable Notes, we recognized Exchange Options, with an
estimated fair value of $231.5 million as a derivative liability. As a result of the Exchange Transaction,
$100.0 million in par value of the Exchangeable Notes were
retired and the related Exchange Options, with a notional amount of
14.1 million shares, were settled at fair value. The Exchange Options are indexed to Class A
Common Stock, have a notional amount of
88.9 million shares at July 9, 2013 and December 31, 2012 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 July 9, 2013, the Exchange Options' estimated fair value was
$0 . At December 31, 2012, the Exchange Options ’ estimated fair value
of
$5.3 million was reported in Other current liabilities on our consolidated balance sheets. For the 190 days ended July 9, 2013 and the years ended
December 31, 2012 and 2011 , we recognized gains of $5.3 million , $1.4 million and $159.7 million , respectively, from the changes in the estimated fair value in
Gains on derivative instruments in our consolidated statements of operations. See Note 11, Fair Value, for information regarding valuation of the Exchange
Options.
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 Treasury Bills, actively
traded U.S. Government Treasury Notes and money market mutual funds for which there are quoted prices in active markets or quoted net asset values
published by the money market mutual fund and supported in an active market.
Investments are classified in Level 2 of the valuation hierarchy for securities where quoted prices are available for similar investments in active markets or
for identical or similar investments in markets that are not active and we use "consensus pricing" from independent external valuation sources. Level 2 securities
include U.S. Government Agency Discount Notes and U.S. Government Agency Notes.
Derivatives
The Exchange Options are classified in Level 3 of the valuation hierarchy. To estimate the fair value of the Exchange Options, we used an income
approach based on valuation models, including option pricing models and discounted cash flow models. We maximized the use of market
- based observable
inputs in the models and developed our own assumptions for unobservable inputs based on management estimates of market participants
’ assumptions in
pricing the instruments.
Upon the consummation of the Sprint Acquisition, each $1,000 principal amount of Exchangeable Notes was changed into a right to exchange such
principal amount of Exchange Notes into an amount of cash equal to the product of (i) $5.00 multiplied by (ii) the exchange rate of 141.2429. Therefore, at the
holder's option, each $1,000 of Exchangeable Notes can be tendered in exchange for $706.21 or a redemption price of $0.706. Given the equity underlying the
Exchange Options no longer exists at the closing of the Sprint Acquisition and the value of the redemption is less than par (alternatively, the spot price of $5.00
is less than the strike price of the option of $7.08), the fair value of the Exchange Option immediately prior to the closing of the merger was $0.
F - 75
10.
Derivative Instruments
11.
Fair Value