Derivative Liability

6 Months Ended

Dec. 31, 2011

Convertible Debt and Derivative Liabilities [Text Block]

NOTE 10 – DERIVATIVE LIABILITY

Under the terms of a Securities Purchase Agreement, on the closing date which occurred on November 30, 2007, the Company issued $2,183,000 principal amount 10% Secured Convertible Debentures to the purchasers together with the common stock purchase warrants to purchase an aggregate of 238,009 shares of the Company’s common stock. The Company paid Next Generation Equity Research, LLC (“Next”), a broker dealer and member of FINRA, a commission of $174,640 and issued Next common stock purchase warrants to purchase an aggregate of 12,692 shares of the Company’s common stock at $20.00 per share. Additionally, the Company reimbursed one of the investors $30,000 to defer its legal fees in connection with the financing. The Company used the balance of the proceeds for general working capital.

During 2009, the exercise price per share of common stock for the original 250,701 warrants issued pursuant to the Securities Purchase Agreement was lowered from $20.00 to $4.00.

On May 14, 2010, the Company entered into a further Debenture and Warrant Amendment Agreement with the remaining debenture holders which, among others, reduced the exercise price of 238,009 warrants to $3.20 per share.

During the year ended June 30, 2010, Company repaid all of its convertible debt by issuing 325,467 shares of its common stock for the principal balance of $1,199,450 and repaid the remaining principal balance of $983,550 using cash.

The warrants issued to the investors in November 2007 contain reset exercise price provisions. The exercise price of the warrants does not have fixed settlement provision because it can be lowered if the Company issues securities at lower prices in the future. In accordance with the FASB authoritative guidance, the Company had determined to classify these warrants as derivative liabilities. The reset exercise provisions of the warrants issued to the investors were recorded at their relative fair values at issuance and will continue to be recorded at fair value at each subsequent balance sheet date. Any change in value between reporting periods will be recorded as other income (expense). These warrants will continue to be reported as a liability until such time when they are exercised or expire. The common stock purchase warrants do not trade in an active securities market, and as such, the Company estimates the fair value of the warrants as of December 31, 2011 and June 30, 2011 using a probability-weighted Black-Scholes-Merton option-pricing model using the following assumptions:

	December 31, 2011				June 30, 2011
Warrants:
Risk-free interest rate			0.12	%			0.19	%
Expected volatility			150.69	%			147.73	%
Expected life	0.92 years				1.42 years
Expected dividend yield			-				-

Fair Value:		$	52,494			$	84,713

Expected volatility is based primarily on historical volatility. Historical volatility was computed using weekly pricing observations for recent periods that correspond to the term of the warrants. The Company’s management believes this method produces an estimate that is representative of the expectations of future volatility over the expected term of these warrants. The Company has no reason to believe future volatility over the expected remaining life of these warrants will likely differ materially from historical volatility. The expected life is based on the remaining term of the warrants. The risk-free interest rate is based on U.S. Treasury securities according to the remaining term of the financial instruments.

As of December 31, 2011 and June 30, 2011, the outstanding warrants related to the convertible debentures were 196,195. At December 31, 2011 and June 30, 2011, the Company recorded a derivative liability of $52,494 and $84,713, respectively, related to the warrants. For the three months ended December 31, 2011 and 2010, gains from the change in fair value of derivative liabilities were $8,417 and $121,612, respectively. For the six months ended December 31, 2011 and 2010, gains from the change in fair value of derivative liabilities were $32,219 and $157,092, respectively. For the three and six months ended December 31, 2011 and 2010, no gain or loss from the extinguishment of derivative liabilities was earned or incurred as no warrants were exercised.

GOLD HORSE INTERNATIONAL, INC. 10-Q