Suppose it is mid - April 2 0 2 4 . You are a risk management specialist
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Suppose it is midApril You are a risk management specialist employed by RiskX, a company which is located in Redlands, Australia. RiskX specialises in providing mining companies with expert advice regarding their various risk management needs.Ms Susie Glass who is treasurer of WeMineGold contacts you to discuss the companys financial risk management. WeMineGold is a Western Australian gold mining company producing gold from one of Australia's highestgrade major goldfields, with plans to increase its size and valuation over the next few years. WeMineGold is a growth company that aims to have a growing cash flow from expanding gold mining operations and its exploration is seeking up to million ounces of gold. The company has invested heavily in developing the goldfield and commenced extracting gold and gold production from its underground mines.
The companys profit and loss are subject to the price change of gold. The company will benefit US$ for each cent increase in the price per ounce of gold sometime in midOctober
As the market price of gold is quite volatile, the company is considering using some strategies to manage its risk exposure.
Though Susie learned the basics of derivatives like forwards, futures and options in her undergraduate Derivatives class, she would like to receive detailed advice about derivatives positions and potential outcomes of various strategies. More specifically, Susie is considering the following strategies:
a Doing nothing.
b Using gold futures contracts traded in the COMEX division of the Chicago Mercantile
Exchange CME Group.
c Using OTC forward contracts with the DerivativeX Bank, a financial institution Susie has
worked with in the past.
d Using OTC option contracts with the DerivativeX Bank.
Furthermore, Susie has heard that derivatives can be very dangerous and might lead a company o a financial ruin. Susie learned from her lecturer in her undergraduate class that some large companies such as the Metallgesellschaft, a German company, have suffered huge losses in trading derivatives. Susie is thus very concerned about potential risks arising from using derivatives instruments.
a What is the company's exposure measured in ounces of gold?
b Which futures contract should WeMineGold use and what position should it taken long or short if it wants to use strategy b to hedge the exposure? Why?
c Provide an explanation without calculations what option contracts puts or calls and what positions long or short are suitable for the needs of the company, should the company decide to go with strategy d
d Provide a thorough and clearly arranged comparison of the four strategies as listed above and discuss advantages and disadvantages of each strategy.
e What are other major risks faced by WeMineGold apart from the risk arising from gold price fluctuations? Provide a brief explanation of these risks.
f Discuss whether WeMineGold should use derivatives and if WeMineGold uses derivatives, what areas should WeMineGold be aware of when using the derivatives.
Related Book For
Finance Applications and Theory
ISBN: 978-0077861681
3rd edition
Authors: Marcia Cornett, Troy Adair
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