7244AFE : Derivatives & Risk Management Assignment – 2017T2

Risk Management Assignment Task :

Suppose you are a risk management professional working for iManageRisk firm which is located in Nathan, Queensland. iManageRisk provides consulting services to firms such as airline companies and mining companies on their risk management. Mr. Robert Lee, the treasurer of QGold Corporation, approaches you today (assume it is now September 2017) to ask you for advice on the financial risk management of his company. QGold Corporation is an Australian gold mining company producing gold from Australia's highest-grade major goldfield at Charters Towers in north eastern Australia, with plans to increase its size and valuation over the next few years. QGold 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 20 million 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$900 for each 1 cent increase in the price per ounce of gold sometime in mid-December 2017. As the market price of gold is quite volatile, the company is considering using some strategies to manage its risk exposure. One way to hedge these exposures is to use futures contracts. There are futures contracts traded in the COMEX division of the Chicago Mercantile Exchange (CME) Group. In your report, please devise a hedging strategy for QGold. (1) What kind of futures should QGold use and what position should it take if QGold wants to use gold futures to hedge the exposure? Why? (2) What is the optimal hedge ratio? Note: You can use monthly data for spot and futures prices in the past two years. The price of gold (monthly, in US$) at the spot market and the price of gold futures can be obtained from the Bloomberg terminals located in the Trading Room. (3) What is the company's exposure measured in ounces of gold? (4) How many gold futures contracts should be traded? Note: Check the Chicago Mercantile Exchange website for the specification of gold futures. http://www.cmegroup.com (5) What is the initial margin requirement in April 2017? [1 mark, criterion#3] (6) What are other major risks faced by QGold apart from the risk arising from the price change in gold?