American Barrick Resources Corporation: Managing Gold Price Risk
Derivative Cases
Case 2
American Barrick Resources Corporation: Managing Gold Price Risk
1. Hedging Motivation In terms of the gold mines owners, they hedge nothing against the price drop risk of gold output. As the profits, cash flows and stock price were tied of gyrations in the price of gold. As to the gold, there was always a ready market for their product, at market prices, once extracted from the earth and refined. Hedging against the risks can protect the downside of gold price, enable the both the shareholders and investors to share the price premium, the high operation leverage and high sunk costs, limit the ability to adjust production and lock-in the low total costs. Historically, American Barrick Resources Corporation’s hedge position had allowed it to profit handsomely and to sell its commodity output at prices well above market rates. Moreover, the firm’s insistence on bearing low financial was attributed to an earlier failed business experience by Mr. Munk and his subsequent distrust of high leverage. Investors also desire some exposure to gold prices, but they want this exposure managed prudently. But by hedging against the gold risk, shareholders may sacrifice the upside of gold price, ahead the unsystematic risk. 2. Vehicles of Hedging Gold Financings: American Barrick used bullion loans and gold-indexed underwritten offerings to raise funds for capital expenditures to develop the mine. American Barrick needed to repay the loan to Toronto Dominion Bank in monthly installments in ounces of gold at an interest rate of about 2% per year. The bullion loan was collateralized by the assets of the mine which is different from gold-indexed Eurobond offerings. In both of these gold financings, the investor benefits not only from increased volumes of gold but also from increased gold price. As for forward sales, from the EXHIBIT 9, a sharp drop in gold prices in 1984 and 1985 led to the first forward sales of gold at American Barrick. But when the
Case 2
American Barrick Resources Corporation: Managing Gold Price Risk
1. Hedging Motivation In terms of the gold mines owners, they hedge nothing against the price drop risk of gold output. As the profits, cash flows and stock price were tied of gyrations in the price of gold. As to the gold, there was always a ready market for their product, at market prices, once extracted from the earth and refined. Hedging against the risks can protect the downside of gold price, enable the both the shareholders and investors to share the price premium, the high operation leverage and high sunk costs, limit the ability to adjust production and lock-in the low total costs. Historically, American Barrick Resources Corporation’s hedge position had allowed it to profit handsomely and to sell its commodity output at prices well above market rates. Moreover, the firm’s insistence on bearing low financial was attributed to an earlier failed business experience by Mr. Munk and his subsequent distrust of high leverage. Investors also desire some exposure to gold prices, but they want this exposure managed prudently. But by hedging against the gold risk, shareholders may sacrifice the upside of gold price, ahead the unsystematic risk. 2. Vehicles of Hedging Gold Financings: American Barrick used bullion loans and gold-indexed underwritten offerings to raise funds for capital expenditures to develop the mine. American Barrick needed to repay the loan to Toronto Dominion Bank in monthly installments in ounces of gold at an interest rate of about 2% per year. The bullion loan was collateralized by the assets of the mine which is different from gold-indexed Eurobond offerings. In both of these gold financings, the investor benefits not only from increased volumes of gold but also from increased gold price. As for forward sales, from the EXHIBIT 9, a sharp drop in gold prices in 1984 and 1985 led to the first forward sales of gold at American Barrick. But when the