Sons of Midas Case Study

3191 Words7 Pages

Question 1

The CEO of Sons of Midas (company) should be concerned about the volatility given the inconsistent movement of gold prices and currency fluctuations associated with US dollars (USD) in relation to Australian dollars (AUD). This can result in unexpected outcomes to the company’s profit & loss.

Without an effective hedging strategy, the company is exposed to volatility in gold prices and currency fluctuations between USD and AUD. As production costs incurred in AUD are expected to be constant at a volume of 50,000 troy ounces. However, as the revenue of the company is generated in USD this exposes the company to negative profitability if the AUD appreciates against the USD. Furthermore, decrease in gold prices also affects revenue and the profit margin of the company. The company can protect itself by entering into forward or futures agreement with its costumers to minimize the impact of volatility on fluctuations associated with the exchange rate and gold prices. The following factors necessitates the need for reducing volatility:

• There is a direct correlation between depreciating AUD against USD and gold prices – as gold prices fall, AUD depreciates against USD. Given that global gold sales are down by 12% and are expected to significantly decrease in 2014 . This creates uncertainty and puts pressure on gold prices.

• The company is trading in USD; any possible weakening in USD will put pressure on the company’s bottom line. However, the company is naturally hedged where movement in gold prices offset risks associated with exchange rate fluctuations to customers in USD. A weakening USD is likely to result in an increase in gold prices given the inverse correlation between USD exchange rate fluctuations...

... middle of paper ...

...on if the gold price rises and goes against market expectations. From a conservative standpoint, bought put option, straddle and strangle are best options despite the higher premium involved since it produces gains when gold prices fall and limits losses or in some cases even provides a gain when gold prices rises.

Overall conclusion:

It is highly recommended that the company incorporate the use of options in its hedging strategy, as the gold commodities market is increasingly volatile and the use of forward and futures contracts alone exposes the company to losses if the forward and futures move against market expectation. Options despite its complexity if utilized and monitored effectively can minimize the downside exposure in forward and future contracts with losses restricted to the option premium if the hedging strategy goes against market expectations.

Open Document