Case Study : American Barrick
In the absence of hedging program using financial instruments, how sensitive would Barrick earnings and cash flows 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?
In 1992, American Barrick produced and sold over 1,280,000 ounces of gold at an average price of $422 per ounce, while the market price was $345 per ounce. If there is no hedging program, American Barrick needs to sell the gold at price $345 per ounce. Hence, the net income and cash flow from operation will be declined to $97.5 million and $205.4 million respectively. (See table I)
Table I: The comparison between the American Barrick Performance under hedging and no hedging
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Considering on the market without hedging program, when the price of gold changed 1 percent, the net income and cash flow from operation will be changed 3.56 percent and 1.69 percent, respectively. The net income also caused the changed in shareholder’s book value, 0.35 percent change according to 1 percent change in gold price. Therefore, if the gold price increased, it would increase the net income and shareholder’s book value. The stock will be more attractive to the investors and drive the stock price increasing. By contrary, if the gold price decreased, the shareholder’s book value would be decreased and the stock price would be decreased, also. (See table II)
Table II: The effect on 1% change in gold price
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There are a lot of exposures on the gold price such as the political instability, inflation, government policy and new findings in gold mines. If there are no financial contracts such as option, forward or insurance, the firm might need to tighten the financial policies to be more conservative. In addition, the firm should improve the innovative financing techniques and instruments to prevent the financial risk. Moreover, the firm might need to consider
In 1992, American Barrick produced and sold over 1,280,000 ounces of gold at an average price of $422 per ounce, while the market price was $345 per ounce. If there is no hedging program, American Barrick needs to sell the gold at price $345 per ounce. Hence, the net income and cash flow from operation will be declined to $97.5 million and $205.4 million respectively. (See table I)
Table I: The comparison between the American Barrick Performance under hedging and no hedging
[pic]
Considering on the market without hedging program, when the price of gold changed 1 percent, the net income and cash flow from operation will be changed 3.56 percent and 1.69 percent, respectively. The net income also caused the changed in shareholder’s book value, 0.35 percent change according to 1 percent change in gold price. Therefore, if the gold price increased, it would increase the net income and shareholder’s book value. The stock will be more attractive to the investors and drive the stock price increasing. By contrary, if the gold price decreased, the shareholder’s book value would be decreased and the stock price would be decreased, also. (See table II)
Table II: The effect on 1% change in gold price
[pic]
There are a lot of exposures on the gold price such as the political instability, inflation, government policy and new findings in gold mines. If there are no financial contracts such as option, forward or insurance, the firm might need to tighten the financial policies to be more conservative. In addition, the firm should improve the innovative financing techniques and instruments to prevent the financial risk. Moreover, the firm might need to consider