Assignment
GC Enterprises Ltd is a medium sized retailer that operates a chain of stores throughout the east coast of Australia as well as having a significant online presence. Jenny Collins was recently appointed to the position of Chief Financial Officer of GC Enterprises Ltd. One of her first tasks was a comprehensive review of the company's financial operations. In her report, she recommended that GC Enterprises Ltd should utilise share options to leverage exposure to the Australian share market to earn returns as well as to protect GC Enterprises Ltd's shares from decreases in value. The Board of Directors of GC Enterprises Ltd must decide whether to accept this recommendation. However, the members of the Board of Directors have little, if any, understanding about share options. Therefore, they have requested some basic information on share options from Robyn West, who is GC Enterprises Ltd's Chief Accountant. Robyn West has, in turn, requested that you, as one of the company's accountants, draft a memorandum to the Board of Directors for Robyn West's signature.
Task
Draft a memorandum for Robyn West to sign that explains share options
You should cover both (i) call options and (ii) put options as well as both the option taker (buyer) and the option writer (seller). You should focus on options to buy shares.
Your memorandum should address the following topics:
1. What is an option? Distinguish call options from put options. What are the features of call and put options?
2. Who are the parties to (i) a call option and (ii) a put option? What are their rights and obligations?
3. Explain the difference between settlement through delivery and net cash settlement. Focus on options for shares.
4. Explain what would happen on exercise date for both the option taker (buyer) and the option writer (seller) if: (i) the market price of the shares is above the exercise price ; and (ii) the market price of the shares is below the exercise price. Which parties would make a gain or loss in these situations? You may find it useful to use an example to explain this.
5. Explain how GC Enterprises could use options to protect against decreases in the value of their issued shares.
6. Explain why call and put options are financial instruments in accordance with AASB 9 Financial Instruments. What type of financial instruments are they? Explain whether call options and put options are classified as financial assets and/or financial liabilities by option takers (buyers) and option writers (sellers) in accordance with AASB 9 Financial Instruments?
7. Explain the measurement requirements (on initial recognition and subsequent to initial recognition) for call and put options in AASB 9 Financial Instruments.