Background
OceanaGold is a multinational mid-tier gold mining company based in New Zealand
engaged in the extraction and processing of gold at various sites globally. OceanaGold’s
forecast quarterly production (scaled down for ease of calculation) for the next two
quarters is presented in the following table.
Quarter Gold (Troy
Ounces)
June 2019 2,000
Sept 2019 2,200
Dec 2019 2,500
OceanaGold’s sales of gold metals are denominated in US dollars.
In addition, OceanaGold has a long-term variable rate loan (5-year maturity) of AUD
50m and a variable rate loan (3-year maturity) USD 20m. The next reset dates are the 30th
June and 30th September 2019, respectively.
Required:
Assume that you are a recently appointed hedge strategist with OceanaGold and that you
have been requested to prepare a report for presentation to their Investment Strategy
Committee at its next meeting. You have been specifically requested to address the
following issues:
Section I (25%)
(a) To identify the specific financial risk exposures faced by OceanaGold (please
limit the financial risks to what is taught in this unit). In this section you MUST
discuss the outlook (forecast) for each underlying variable and identify whether it
will present a risk to the firm. You need to provide adequate justification for your
responses. (15%).
(b) Make firm recommendations on whether to hedge all, part or none of the
financial risk exposures that you identified in part (a) above. You MUST provide
some explanation for each of your recommendations. (i.e. the reasons for
suggesting this strategy. (You are not required to specify the type of derivative to
be used to hedge in response to this question). (10%)
Section II (25%)
(c) To make recommendations on which derivative instruments (for example,
options, futures etc.) to use to implement any hedges that you have
recommended in part (b) above. Once again, you MUST explain your
FIN30014 Financial Risk Management Sem 1, 2019
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recommendations (i.e. justify the choice of derivative instrument). This means
that you will need to provide very well researched and fully explained reasons for
your responses to parts (a & b). (15%)
(d) Irrespective of your recommendations in parts (b) and (c) above, assume that
OceanaGold wishes to hedge 100 percent of its Gold deposits 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 reason for choosing futures or options
d. the contract months used
e. whether you are going long or short futures and, in the case of options
whether you are buying puts or calls
f. 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 as presented below.
Please include
calculations of the
number of contracts
in the appropriate cell
Type of Risk
Exposure to be hedged
Proportion of the exposure to
be hedged
Derivatives i.e. Futures/or
Options etc.
Explain the choice of derivative
instrument/strategy
No. of Contracts
Contract months
Long/short/
Put/Call
Strike Prices,
premiums/Futures prices etc.
(10%)
FIN30014 Financial Risk Management Sem 1, 2019
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Section III (25%)
(e) Propose TWO option combination strategies that involve more than one option
contract for the USD variable rate loan (USD 20m), for all relevant risks
faced by this portfolio. OceanaGold’s management has expressed a desire to
retain some of the upside benefits that hedging with options can permit but
without paying a lot of money in option premiums. That is, your recommended
strategies should provide a “reasonably effective” hedge but keep the option
premium payment limited to a “reasonable amount” (it does not have to be zero!).
As the strategist, it is up to you what you consider “reasonable” for this purpose.
You must also describe the benefits and possible shortcomings of your proposed
option strategies. You must use actual option data to illustrate your option
strategies and to hypothetically demonstrate their benefits and shortcomings.
Calculate the number of contracts required for each strategy and provide the
strike prices and total premium costs.
Sample Solution
