Topics: Forward contract, Risk management, Spot price Pages: 7 (2150 words) Published: January 23, 2012
CASE: American Barrick Resources Corporation : Managing Gold Price Risk 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?

Particulars for yr 1992($ million)| |
Pretax earnings (Exhibit 2)| 223|
Reductions in earning of gold sold at spot (1280mn oz x (422-345) (Exhibit 12)| (99)| Proforma Pretax Earnings| 124|
Taxes @ 21% (Exhibit 2) | (26)|
After Tax Earnings| 98|

Thus in absence of risk management program the American Barrick stock would be more sensitive to gold price changes. This could also be observed from Exhibit 4 where the return on Barrick’s stock is continuously increasing as compared to other unstable major stocks in gold mining sector.

Elasticity of Earnings & Profit for 1% change in Gold Price

1% change in gold price ($345)| $3.45|
Number of ounces| $1,280m|
Additional pre-tax profits| $4.4m|
Additional after-tax profits| $4.4 x (1-.21) = $3.5mn|
Additional profits as % of earnings| 3.5/98 = 3.5% (approx)| Cash Flow = Earnings + Noncash charges| 98mn + 69mn = $167mn| Additional profits as % of cash flow| 3.5/167 = 2.1%|

Thus with 1% change in gold price the earnings of Barrick would change by 3.5%.

The firm can manage its gold price exposure in following three ways:

1. Diversifying its business

2. Hedging against the gold price risk

3. Insuring against the gold price risk

Hedging involves entering into financial contracts and so does insuring against the gold price risk. Thus without being involved in any financial contracts Barrick can reduce its gold price exposure only by diversifying its business.

2. What is the stated intent of ABX’s hedging program? What should be the goal of a gold mine’s price risk management program? Stated intent
American Barrick Resources Corporation is one the most financially successful gold-mining concerns in the world. The main stated intent of ABX’s hedging program was to profit handsomely even during a downtime, when gold prices are falling. The hedging position had allowed ABX to sell its commodity output at prices well above market rates. The main motive of the hedging program was to profit and gain an advantage over its competitors by hedging, at a time when the prices of gold were low and also interest rates were falling. Thus, the main intent of the hedging program was to position the organization as a low- cost commodity producer, willing to sacrifice potential profits from gold price peaks in order to level out potential losses in the future.

Goal of a gold mine’s price risk management program
The primary goal of a gold mine’s risk management program is to hedge the risk of falling gold prices and low interest rates, to ensure the minimum sale price of gold even when prices are declining. One of the main goal is to achieve financial stability. The risk management programs motive is to hedge risk in order to plan the future cash flows with certainty. Also, at a time, when an organization has immense production initially itself, the risk management program enables the firm to earn a predictable, rising earnings profile in the future inspite of rising production. Thus , the intent of the risk management program is to hedge the risk in such a manner, that its production decisions are not affected by the market price of gold.

3. What would convince you that a price risk management program created value for its shareholders ex ante? The American Barrick Resources Corporation, had since its inception a strategy of efficient risk management system to protect or hedge itself from the fluctuations in the Gold prices. The various risk management system coupled with favourable circumstances and opportunities of price locking,...
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