Last update 20/11/2019
Adjusted market pricing relates to the fair value pricing of assets held by investors in an investment portfolio. Such assets are debt instruments and equity instruments, with both instruments either being traded in a market/stock/bonds exchange or in a private market.
In comparison to assets, observable active markets for liabilities and equities are much less likely to exist due to contractual and legal restrictions on liability and equity transfers. Even for quoted debt or equity securities, the marke serves as an exit mechanism for the counterparty security holders rather than for the issuer. The quoted price as a result reflects the exit price for the investor rather than the issuer. Adjusted market pricing
IFRS 13 distinguishes such situations from the situation in which an exit market exists directly for the liability or equity instrument. When a quotes transfer price is not available for the issuer but the instrument is held by another party as an asset, management should measure fair value from the asset holders perspective. [IFRS 13 37].
The IASB decided to use the fair value from the investor’s perspective to measure the liability’s fair value when there is no active market for the liability transfer. The IASB believes that the fair value from the viewpoints of investor and issuer should be the same in an efficient market, otherwise arbitrage would result [IFRS 13 BC89].
In such cases, the fair value of the liability or equity instrument is derived by: Adjusted market pricing
- Using the quoted price in an active market for the identical item held by another party as an asset (for example, actively-quoted debt security prices).
- Using other observable inputs if the price in (a) is not available, such as the quoted price in an inactive market for the identical item held by another party as an asset (for example, quoted debt security prices in less active markets). Adjusted market pricing
- Using another valuation technique if the observable inputs in (a) and (b) are not available, such as: Adjusted market pricing
- an income approach — this approach uses a present value technique that takes into account the future cash outflows that a market participant would expect to receive from holding the liability or equity instrument as an asset. Adjusted market pricing
- a market approach — under this approach, fair value is determined using quoted Prices for similar liabilities or equity instruments held by other parties as assets. Adjusted market pricing
The latter, the market pricing approach to adjust market pricing is discussed now. Adjusted market pricing
The guidance in IFRS 13 requires that the use of relevant observable inputs be maximized and the use of unobservable inputs be minimized, with special emphasis on the word “relevant.” In some cases, prices based on transactions (in other words Level 1 inputs) do not represent the fair value for an asset in the market because of distressed sales, forced sales or announcements made after the transactions or after the close of business on the valuation date.Adjusted market pricing
Such market information will have to be adjusted in accordance with the reporting entities’ stated policies for adjusting market pricing.
Fair market value for publicly traded shares Adjusted market pricing
Determining the fair market value is relatively straightforward for shares that are traded on a public exchange. In such cases, the fair market value is calculated by taking the average of the highest and lowest selling prices of the day. If the fair market value needs to be established for a non-trading day, then the averages from the day before and after may be used instead.
Fair market value for private shares
Figuring out the fair market value of non-publicly traded shares is more complex because, unlike public shares, there is no daily pricing data upon which to base calculations. Analysts use a variety of methods to determine the fair market value of private shares, the most common of which is to compare valuation ratios of a private company to those of a comparable public company. Adjusting elements such as risk factors (such as illiquidity of shares in private companies) and future growth also tend to come into play when calculating a fair market value for shares that aren’t publicly traded.
Premiums and discounts
The fair value of shares should be adjusted for the effect of lack of liquidity if market participants would take this into account when measuring the fair value (IFRS 13 69) – May be required if the initial estimate of fair value is based on comparables for public companies (ie. quoted/liquid shares).
The fair value should be adjusted for a control premium if:
- it is not inconsistent with the asset’s unit of account (IFRS 13 14, IFRS 13 69); and
- market participants would include such a premium when measuring the fair value (IFRS 13 69).
Example: Debt obligation with quoted price (a market approach) [IFRS 13 paras IE40-1E42]
On 1 January 20X1 entity B issues at par a C2 million BBB-rated exchange-traded five-year fixed rate debt instrument with an annual 10% coupon. Entity B designated this financial liability as at fair value through profit or loss.
On 31 December 20X1 the instrument is trading as an asset in an active market at C929 per C1,000 of par value after payment of accrued interest. Entity B uses the quoted price of the asset in an active market as its initial input into the fair value measurement of its liability (C929 x (C2 million — C1,000) = C1,858,000).
In determining whether the asset’s quoted price in an active market represents the liability’s fair value, entity B evaluates whether the asset’s quoted price includes the effect of factors not applicable to the fair value measurement of a liability, for example, whether the quoted price of the asset includes the effect of a third-party credit enhancement if that credit enhancement would be separately accounted for from the perspective of the issuer.
Entity B determines that no adjustments are required to the asset’s quoted price. Accordingly, entity B concludes that the fair value of its debt instrument at 31 December 20X1 is C1,858,000. Entity B categorises and discloses the fair value measurement of its debt instrument within Level 1 of the fair value hierarchy.
This example is used as a reference to the discussion on adjusting the market price as follows:
Using quoted prices and observable inputs
A quoted asset price may have to be adjusted to derive the fair value of the corresponding liability or equity instrument if there are asset-specific factors that are not applicable to the liability or equity instrument. For example, a quoted debt security may be secured by a third-party guarantee. The quoted price of such a security would reflect the value of the guarantee (see example above). The issuer should exclude the effect of the guarantee from the quoted price if the issuer is measuring only the fair value of its own liability and the unit of account excludes the guarantee. [IFRS 13 39(b)].
If management uses the quoted price for a similar (but not identical) debt or equity instrument to value its own debt, it would have to adjust for any differences in the characteristics between the debt or equity instruments. [IFRS 13 39(a)]. The price of the asset used to measure the fair value of the corresponding liability or equity instrument should not reflect the effect of a restriction preventing the asset’s sale. [IFRS 13 39].
See also: Estimating the market rate of return when volume or activity is slight as a similar way of approaching adjusted market price.
See also: The IFRS Foundation
