American Barrick Case

American Barrick Case          

1. In the absence of a hedging program using financial instruments, how sensitive would Barrick stock be to gold price changes? For every 1% change in gold prices, how might its stock be affected? How could the firm manage its gold price exposure without the use of financial contracts?

For every 1% change in gold prices, its stock might change 5.1% in the absence of a hedging program. Using the realized and actual prices in Exhibit 12, we can work out the difference of profit between hedging or not. We can get the unhedged equity by subtracting the equity from Exhibit 2 from the difference. Then we run a regression model between the percentage changes in the unhedged equity against the percentage changes in the actual gold prices: %equity=β+α*%gold price+ε.

Without the use of financial contracts, the firm could manage its gold price exposure by gold financings. Specifically, it raised capital through publicly traded gold royalty trust, bullion loans and gold-indexed Eurobond offerings.

1. What is the stated intent of ABX’s hedging program? What should be the goal of a gold mine’s price risk management program?

The stated intent of ABX’s hedging program is to give American Barrick extraordinary financial stability. It protects them from the impact of dips in the gold price, allows them to plan their cash flows with confidence, and, in combination with their rising production, offers investors a predictable, rising earnings profile in the future.

The goal of a gold mine’s price risk management program should be to reduce potential losses in gold price troughs and not to cap upside potential in gold price rallies. In other words, a gold mine should shed some of its gold price risk while maintaining flexibility to profit from rising gold prices.

1. How should a gold mine which wants to moderate its gold price risk compare hedging strategies (using futures, forwards, or with insurance strategies (using options)? On what basis should these decisions be made? Pleasqe give examples using the current prices of gold futures and options (if possible). Once a firm has decided on either a hedging or an insurance strategy, how should it choose from among specific alternatives?

In a forward sale of gold, a party commits to deliver a specified quantity of gold, at a specific date, for a price set at the beginning of a contract. Hedging eliminated American Barrick’s downside exposure but also its ability to benefit if prices rose. Option-based insurance could mitigate the risk of price declines while allowing the firm to retain some of the benefits of rising prices. In executing a “collar” strategy, the firm simultaneously bought put options and sold call options on gold. By using the premiums received from the sale of calls to purchase puts, a collar strategy required no initial cash outlay.

...