Finance Case

Introduction

The purpose of this report is to conduct an analysis of Financial risk exposures faced by Metal Mining Ltd Company, and to give suggestion to the Board of Directors how to use the derivatives to hedge against the risks.

There are three main types of financial risks faced by MML, it is interest rate risk, foreign exchange risk and commodity price risk. Based on the analysis, it is going to give the recommendation to directors that how much, which derivatives the company need to use for hedging. In addition, there are three schedules for hedging are provided. It is using futures and options to hedge the expected production of copper in August, how foreign currency swaps can mitigate the exchange rate risk. The last one is how to have effective hedging using options with reasonable price

Financial Risks faced by MML

Interest Rate Risk

MML is serving the A$600 million, which is floating rate, not the fixed one. The rate is based on 3 months Australian dollar bank bill swap rate plus 2.5%. By using the floating rate, MML can benefit from the deduction of interest rate, however, they expose the risk of increasing the amount paying to the bank. If the interest rate increases against them, they need to carry more cost. For instance, the interest rate just goes up by 25 basic points, they need to pay addition A$15 million per year.

Foreign exchange rate risk

MML's sales of Gold and Copper are denominated in US dollar, so their income is US dollar, while they are operating in Australia. Most of all, the company need to serve the debt by Australian dollars. They bear the risk of foreign exchange, in this case is between AUD and USD. In additions, Australian dollar strengthen against US dollar due to the rising commodity price could make MML worse off. Since they are the exporter, which is favor more from the weak Australian dollar.

Commodity price risk

The gold price has traded at near record high, which is around US$1600-1700 per ounce, due to the unrest in the Middle-East and the turmoil situation in European Debt Crisis. However, some good signals from US economy caused gold price down below $1700.

In addition, the copper price has in uptrend due to the strong demand from India, China and US economy. However, the uncertainties about the strength of Chinese growth make copper price volatile recently.

Because of above reasons, MML bear the risk of declining in price of gold and copper, which can wipe out their profit significantly.

How much MML need to hedge for the three risk exposures above

Interest rate risk

MML is in the position of borrower, so the company worries about the increasing in interest