Financial Risk Management Consultancy Finance Essay - Free Essay Example

Sometimes companies are faced with tough investment decisions to make. Mostly, these are decisions that affect the future growth or perpetuity of a particular company. Each company would like to know the expected returns in future so that it may plan ahead. However, with the current volatility in the market where prices are fluctuating without warning, it becomes hard to pinpoint what a company will be worth in future or at what price the commodities of the company will be at a certain date in future. This dilemma is faced by QGold Corporation. This company aims to expand. In so doing, it must make sure that its future is stable. Since the company gets its revenue from the sale of gold and gold products, it must have a way of making sure that these prices are stabilized to prevent unforeseen losses in the future. This report investigates the options available for QGold Corporation and recommends the use of hedging through the investment in the futures contracts market. The future contracts market offers price stability by enabling QGold Corporation have a definite expected return figure for when the contracts mature and thereby enabling the management to make viable decisions in the company. Introduction This report aims at investigating the avenues of risk present in QGold Corporation, the risk factor exposed to QGold Corporation, the current system in use by QGold Corporation in the management and/or mitigation of financial risk in their organization and provide ways and recommendations which QGold Corporation may use to eliminate financial risk in their system. This report will use a number of methods and approaches in the analyses of the financial risk in QGold Corporation. Correlation analysis will be employed as well as discounting of cash flows. Since the company aims at expanding its capital base and scope in the near future, and since the profit or loss realised by the company is solely dependent on the market prices of the gold mined by the company, there is a need to make sure that profitability is guaranteed in future in the volatile gold market. Discounting of the cash flows and futures will be done to be able to analyse this particular case. Correlation will also be used to find the profitability ratio of the gold now compared with the futures prices of the same as given arbitrarily by the Australian financial futures reports. QGold Corporation: Brief history QGold Corporation is a company based in Australia that deals with the mining, processing and sales of gold and gold products. QGold Corporation produces its product from Charter Towers gold field in Northern Australia. This field is deemed to be one of the highest grade fields in all of Australia. The company has a vision of expanding its operations beyond northern Australia. As such, massive capital has been employed in the prospecting of gold. It seeks to be capable of producing up to 50 million ounces. Those expansion policies are already underway as the company has started extracting gold and processing gold products. Financial risk factor in QGold Corporation QGold Corporation gets its revenue from the extraction, processing and sale of gold and gold products. Due to this, the corporationÃÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¡Ãƒâ€šÃ‚ ¬ÃƒÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾Ãƒâ€šÃ‚ ¢s profit and loss is dependent on the price fluctuations of the gold. As projected by the board of the company, the company is expected to benefit one dollar (USD) for every one cent increment in the price per ounce of gold in November 2012. However, the market for gold in Australia and the world at large is currently very volatile and taking into consideration the massive amounts of money and input, both in personnel and other resources, it is crucial for QGold Corporation to manage its risk factor so as to try and avoid losses. Reasons for want of risk management in QGold Corporation There are quite a number of reasons warranting QGold Corporation to manage their financial risks and their level of exposure to risk. Triantis (2000, p.561) sums some of these risks as follows in the succeeding discussion. The company wants to decrease the probability of it becoming bankrupt, find ways of bettering its terms of transactions with its clients, suppliers as well as its employees. QGold Corporation also seeks to reduce cases of value-decreasing investment decisions such as prospecting mines without having them initially investigated to prove that there is existence of deposits. According to Newland Tanaka (2010, p. 24) entrepreneurial ship requires a degree of ingenuity so as to achieve its targeted revenues. Similarly, QGold Corporation is also aiming at trying to minimize cases that would to the decrease or falling short of projected and targeted returns on investments. Gold price fluctuations as an avenue of risk for QGold Corporation Gold price fluctuations in the market have been a factor that has led to the collapse and sometimes, the rapid rise of many gold mining corporations in Australia. According Wikiposit (2012) the average price of one ounce of gold in 2012 was placed at USD 1658.04. This is an increment from the average price of one ounce of gold in the year 2011 which was placed at USD 1534.22 (Wikiposit, 2012). Evans Brearley (1999, p. 696) claims that the price increase in gold resources and production in 1980s and in the subsequent years have precipitated into the increase in the prices of gold. This increase in production occurred as a result of advancement in technology and use of carbon-in-pulp and carbon-in-leach methods of production in the mining fields (Evans Brearley, 1999, p. 696). QGold Corporation expects the price of gold to increase in the coming months and this is confirmed by the PriceWaterHouseCoopers (2012, p. 6) who conceded in their research that 80% of the executives and key players in this industry were interviewed said that they expected the prices of gold per ounce to keep on rising. However, the volatility factor of prices of gold canÃÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¡Ãƒâ€šÃ‚ ¬ÃƒÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾Ãƒâ€šÃ‚ ¢t be out ruled. Due to this, the company has decided to caution itself against impending losses by investing in the futures market through derivatives of the futures contract. Hedging strategy and the futures contract as a method of risk mitigation in QGold Co. Dodd (2001, p. 1) defines derivatives as financial contracts that are meant to bring about changes in market prices of a particular commodity without actually bringing about a change of ownership. According to Campbell et. al (2006), hedging is making a particular investment as a way of trying to mitigate the risk of adverse and unpredicted fluctuations in prices of a certain asset. A hedge is a very good way or reduction of risk. This is done by investing in the futures commodities market. According to Wikiposit (2012), the price of gold in October 2012 commodities futures market is given as being USD 1691 per one ounce of gold. The current price of one ounce of gold is given as USD 1674. Wikiposit (2012) also give the margin requirement for September 2012 as being USD 1687.60 per one ounce of gold. This figure, USD 1674, is not guaranteed to rise in future. As much as all the conditions as presented by PriceWaterHouseCoopers (2012) point and predict a rise in the future price of th e ounce of gold, the market could behave otherwise and adverse effects on the prices realized. If this happened, QGold Corporation could find itself exhibiting losses. To cushion the company from such losses in the unpredictable future, hedging should be employed here. QGold should employ the use of derivatives to enable it avoid future losses. However, the use of these derivatives should be well monitored as sometimes their misuse could lead to massive losses. Jo et. al (n.d, p.2) argues that the unethical or unprofessional use of derivatives could lead to a global financial crisis. QGold should take an offsetting position in case it decides to invest in the futures commodities market. Finnerty Grant (n.d) defines offset hedging as the liquidation of a futures position through making a transaction today of an equivalent value thereby getting rid of the futureÃÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¡Ãƒâ€šÃ‚ ¬ÃƒÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾Ãƒâ€šÃ‚ ¢s delivery requirement. Currently, QGold Corporation has an exposure of a value exceeding 50 million ounces of gold. Data borrowed from CME group (2012) gives two options of futures for gold, that is, for the months October 2012 and December 2012 respectively. QGold Corporation may decide to either invest in both of these futures or one of them depending on their stand regarding risk management. Recommendations After the options available to company QGold have been analyzed in the preceding discussion, some recommendations are done as stipulated in the subsequent paragraphs. Firstly, QGold should look for ways of minimizing the risk exposure inside the firm. Before resources are employed in prospecting for mine fields, an intensive research and study should have been carried out beforehand to ascertain the availability of the said minerals. Sometimes prospecting might be carried out on a mine only to find that there are no mineral deposits thereby resulting into loss of massive resources and time. QGold Corporation should also get a good hedge fund managing company to offer them advisory services on how they will invest in the futures market to avoid losses resulting from unethical use of derivatives. The best futures should be identified and invested in. QGold Corporation should continue with their expansion plans and utilize its size for market advantage. A big company is more capable of exploiting the market better than a small company. Conclusion In conclusion, it has been made evident in matters discussed in this report that QGold Corporation will be able to avoid future losses by engaging itself in hedging through investing in the future contracts market. The volatility of the gold market in Australia and the world in general makes it very hard for companies to predict their future returns. This is because prices may fall leading to a decrease in the returns or they may rise resulting to an increase in the level of returns. Since the future lies unknown and no one knows for certain what will occur, itÃÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¡Ãƒâ€šÃ‚ ¬ÃƒÆ' ¢Ãƒ ¢Ã¢â€š ¬Ã… ¾Ãƒâ€šÃ‚ ¢s better to prepare to the future today. To prevent imminent losses in the future, investing today in a futures market will guarantee a company a specific return to investment regardless of the risks involved or the prices that will be existing at that time. However, QGold Company may also find itself making losses where the market prices that will be existing at the time of maturity of the futures contract exceed the price of the futures. Despite that notion though, investing in the futures contracts would be the best measure for QGold Corporation to take as it totally eliminates all risk, gives definite expected returns in future and allows the corporation the freedom to make other management decisions without fear.