Fair Value of Financial Instruments

9 Months Ended

Sep. 30, 2012

Fair Value of Financial Instruments

Note 8.  Fair Value of Financial Instruments

The carrying value of cash and cash equivalents, receivables, accounts payable and accrued expenses approximates their fair values because of the short-term nature of these instruments. The carrying value of the Notes approximates fair value since the related rate of interest approximates current market rates. Management believes Opexa is not exposed to significant interest or credit risks arising from these financial instruments.

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value maximize the use of observable inputs and minimize the use of unobservable inputs. Opexa utilizes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable.

● Level 1 — Quoted prices in active markets for identical assets or liabilities. These are typically obtained from real-time quotes for transactions in active exchange markets involving identical assets.

● Level 2 — Quoted prices for similar assets and liabilities in active markets; quoted prices included for identical or similar assets and liabilities that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets. These are typically obtained from readily-available pricing sources for comparable instruments.

● Level 3 — Unobservable inputs, where there is little or no market activity for the asset or liability. These inputs reflect the reporting entity’s own beliefs about the assumptions that market participants would use in pricing the asset or liability, based on the best information available in the circumstances.

The following table presents the derivative financial instruments, Opexa’s only financial liabilities measured and recorded at fair value on the Company’s consolidated balance sheets on a recurring basis, and their level within the fair value hierarchy as of September 30, 2012:

		September 30, 2012		Level 1		Level 2		Level 3
Warrant derivative liabilities	$	2,451,524	$	-	$	-	$	2,451,524
Total	$	2,451,524	$	-	$	-	$	2,451,524

The following table provides a summary of the changes in fair value, including net transfers in and/or out, of the derivative financial instruments, measured at fair value on a recurring basis using significant unobservable inputs:

Balance at December 31, 2011	$	-
Fair value of warrant derivative liabilities at issuance	$	2,314,635
Unrealized derivative losses included in other income (expense)	$	136,889
Balance at September 30, 2012	$	2,451,524

The fair value of the derivative liabilities are calculated at the time of issuance using the Lattice option pricing model with Monte Carlo simulation. Opexa records a derivative liability for the calculated value. Changes in the fair value of the derivative liabilities are reported in other income (expense) in the consolidated statements of expenses. The variables used in the Lattice option pricing model for the derivative liabilities during the nine months ended September 30, 2012 include:

	July 25, 2012	September 30, 2012
Market value of common stock on measurement date	$0.64	$0.68
Projected exercise price	$1.25	$1.13
Risk free interest rate	0.56%	0.56%
Warrant lives in years	5	4.88
Expected volatility	193%	193%
Expected dividend yields	0%	0%
Offering price range	$0.64-$1.64	$0.68-$1.68