Assignment Problem:
In your report, please address the issues faced by the client as mentioned in the case. Please follow the general format of a consulting report. 34 marks are related to your addressing of the questions indicated in the case. In addition, another 6 marks are allocated to the conclusion and other aspects of the report (including the format of the report, writing clarity, grammatical accuracy, logical flow, relevance of justification, etc.).
Suppose you are a risk management professional working for Top-Knotch RM - a firm which is located in the Redlands, Queensland. Top-Knotch RM provides consulting services to firms such as airline companies and mining companies on their risk management. Mr. Richard Dolan, the treasurer of IMine Corporation, approaches you today (assume it is now March 2020) to ask you for advice on the financial risk management of his company.
IMine Corporation is an Australian gold mining company producing gold from Australia's highest-grade major goldfield in north eastern Australia, with plans to increase its size and valuation over the next few years. IMine is a growth company that aims to a growing cash flow from expanding gold mining operations and the huge capital growth upside of an exploration company seeking to define up to 15 million troy ounces of gold. The company has invested in developing the goldfield, and commenced extracting gold and gold production from its underground mines.
The company's profit and loss is subject to the price change of gold. The company will benefit US$8,000 for each 1 cent increase in the price per troy ounce of gold sometime in late July 2020. As the market price of gold is quite volatile, the company is considering using some strategies to manage its risk exposure. One way to hedge these exposures is to use futures contracts. There are futures contracts traded in the COMEX division of the Chicago Mercantile Exchange (CME) Group.
In your report, please devise a hedging strategy for IMine.
What kind of futures should IMine use and what position should it take if IMine Gold wants to use gold futures to hedge the exposure? Why? What is the optimal hedge ratio?
Note that monthly data for spot and futures prices (both in US$) for the past five years has been obtained from Thomson Reuters Datastream for you. See Appendix A.
What is the company's exposure measured in ounces of gold?
How many gold futures contracts should be traded? Note: Check the Chicago Mercantile Exchange website for the specification of gold
What is the initial margin requirement in March 2020?
What are other major risks faced by IMine apart from the risk arising from the price change in gold?
In your report, please also address Richard's concerns: Richard is concerned with the use of derivatives. He has heard from his long-term friend, Mr MF, who graduated with a Master of Finance degree from Griffith University, on the dangers of misusing of derivatives products such as futures to firms. Mr MF also mentioned that derivatives pose a danger to the whole financial system, and thus they should be banned. Recently a complex derivatives trade has caused over $5 billion losses at J.P. Morgan. Above all, an investment guru, Warren Buffett, once referred derivatives to as "time bombs" and financial "weapons of mass destruction" (details can be found in Appendix B).
Finally, you also need to address whether the company like IMine should use derivatives.
Please use some source materials (such as academic journal articles and newspaper articles) to support your arguments in your report. Follow a proper referencing and citation style.
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