DERIVATIVE

3 Months Ended

Mar. 31, 2012

DERIVATIVE

The Company’s Convertible 8% Notes issued to Asher Enterprise, Inc. contain a conversion features that allow for conversion into shares at a price discounted from the market price. For each particular note, this amount is set at a fixed percentage of the average of the three lowest closing bid prices over the last 10 days. Additionally, the notes contain a reset provision to the exercise price and conversion price if the Company issues equity or other derivatives at a price less than the exercise price set forth in such warrants and notes. This ratchet provision results in a derivative liability in our financial statements.

We valued the conversion features in its convertible notes using a binomial lattice valuation model. The lattice model values the embedded derivatives based on a probability-weighted discounted cash flow model. This model is based on future projections of the five primary alternatives possible for settlement of the features included within the embedded derivatives, which are: (i) payments are made in cash, (ii) payments are made in stock, (iii) the holder exercises its right to convert the notes, (iv) we exercise our right to convert the notes, and (v) we default on the notes. We use the model to analyze the underlying economic factors that influence which of these events will occur, when they are likely to occur, and the price of its common stock and specific terms of the notes, such as interest rate and conversion price, that will be in effect when they occur. Based on the analysis of these factors, we use the model to develop a set of potential scenarios. Probabilities of each scenario occurring during the remaining term of the notes are determined based on management's projections. These probabilities are used to create a cash flow projection over the term of the notes and determine the probability that the projected cash flow will be achieved. A discounted weighted average cash flow for each scenario is then calculated and compared to the discounted cash flow of the notes without the compound embedded derivative in order to determine a value for the compound embedded derivative.

Roll-forward of Derivative Net Liabilities
Derivative balance at 12.31.2010	$ 40,205
Derivative balance at issuance (January 11, 2011)	$ 40,666
Derivative balance at issuance (March 10, 2011)	$ 39,035

Change due to Mark to Market	$ 3,516
Conversion of Note	$ (44,102)

Derivative balance at 03.31.2011	$ 79,320
Derivative balance at issuance (April 15, 2011)	$ 39,658
Change due to Mark to Market	$ 20,562

Derivative balance at 06.30.2011	$ 139,540
Derivative balance at issuance (July 1, 2011)	$ 48,760
Derivative balance at issuance (July 29, 2011)	$ 45,346
Change due to Mark to Market	$ 78,471
Conversion of Note	$ (58,559)

Derivative balance at 09.30.2011	$ 253,558
Change due to Mark to Market	(59,653)
Conversion of Note	$ (19,960)

Derivative balance at 12.31.2011	$ 173,944
Change due to Mark to Market	(10,694)
Conversion of Note	(134,363)

Derivative balance at 03.31.2012	$ 28,886

During the first quarter, the remaining $30,000 principal of the convertible notes issued in March 10, 2011 has been converted into 7,853,538 shares of non-assessable common stock of the Company, which extinguished the derivative liability resulting in a credit to paid-in capital of $55,017.

The $40,000 principal of the convertible notes issued in April 05, 2011 has been converted into 14,138,272 shares of non-assessable common stock of the Company, which extinguished the derivative liability resulting in a credit to paid-in capital of $28,832.

The $28,000 principal of the $32,500 convertible notes issued in July 07, 2011 has been converted into 24,428,904 shares of non-assessable common stock of the Company, which extinguished the derivative liability resulting in a credit to paid-in capital of $34,126.

The fair value of the derivative liability at March 31, 2012 and December 31, 2011 is $28,886 and $173,944 respectively

CATALYST RESOURCE GROUP, INC. 10-Q