Sandfire Resources NL (SRN) is an Australian mining company primarily engaged in the extraction and processing of gold and copper in Western Australia. SRN has financed the construction cost of some of its recent mine developments with a syndicated bank loan of US$600 million. This loan facility is for ten years and is a floating rate loan priced at 2.5% above the 3 month US dollar LIBOR rate. The next loan rollover date is 31 Dec 2016. SRN also has Euro variable rate debt of EUR200million.
SRN's forecast monthly production (scaled down for ease of calculations in the requirements) for the September and Dec quarters, 2016 is presented in the following table.
| Month |
Gold (Ounces) |
Copper (Pounds) |
| Jul-16 |
2,000 |
500,000 |
| Aug-16 |
2,200 |
700,000 |
| Sep-16 |
2,400 |
600,000 |
| Oct-16 |
2,400 |
600,000 |
| Nov-16 |
2,600 |
700,000 |
| Dec-16 |
2,600 |
700,000 |
SRN's sales of both gold and copper are denominated in US dollars. SRN is unsure of the direction of the financial variables and have appointed you to identify the risks and recommend suitable hedges.
Required:
You have been commissioned by SRN's Board of Directors to prepare a business report that addresses the following requirements:
(a) To identify the financial risk exposures faced by SRN. In this section you MUST discuss the outlook for each variable and the related risk exposure. You need to provide adequate justification for your responses.
(b) To make recommendations to SRN's management on whether to hedge any, all or part of the financial risk exposures that you outlined in part (a) above. You MUST explain your recommendations.
(c) To make recommendations to SRN's management on whether to use options and/or futures (and forwards) to implement the hedges that you have recommended in part (b) above. You MUST explain your recommendations. (It is possible that you elect not to hedge any exposures. If so, the marks available for parts (b) and (c) will be combined and your answer to (b) assessed on that basis).
(d) Irrespective of your recommendations in parts (b) and (c) above, assume that SRN wishes to hedge fifty percent of its November and December production of copper with exchange traded futures or options. Provide a schedule that shows
a. the risk you are hedging against
b. the number of futures and/or option contracts that would be required
c. the contract months used
d. whether you are going long or short futures and, in the case of options whether you are buying puts or calls
e. the option strike prices that you recommend and the premium costs involved.
(Note: in responding to part (d) you only have to implement the hedge - you do not need to calculate any hypothetical future outcome). In this section you MUST show all calculations and include your responses in a table format.
(e) Independently of your responses to part (d), above, use options "combination" strategies only to implement hedging strategies for SRN's December production of copper. SRN's management has expressed a desire to retain the upside benefits that options allow but without paying a lot of money for option premiums. You are requested to propose TWO option strategies with the requirement that they provide a "reasonably effective" hedge but keep the option premium payment to a "reasonable amount" (it does not have to be zero!). It is up to you what you deem to be "reasonable" but your option strategy recommendations should make commercial sense and not be trivial. You should also describe to SRN's management any possible adverse outcomes that your suggested strategies may pose for SRN.
I have this assignment for Financial Risk Management.