AGNUS
ASSIGNMENT
Samples
BUS700 ECONOMICS
Executive summary
In this report, all the macroeconomic variables of Australia will be discussed on the basis of the data from 1990 to 2015 and it is clear that the Australian economy is not much developed. Therefore, it is necessary for the Australian economy has to adopt efficient fiscal and monetary policies in order to achieve the higher growth rate. In this regard, the Australian economy has to more protective in order to protect the Australian economy from the global financial crisis.
Table of contents
2.1 Obtaining data on macroeconomic indicators of Australia. 3
2.2 Producing summary statistics. 3
2.3 Producing pair wise graphs. 11
2.4 Critically analyzing and discussing plausible economic explanations. 16
Predictions of the macroeconomic outlook of Australia. 18
Introduction:
The macroeconomic variables like inflation rate, GDP growth rate, unemployment rate, Exchange rate, import and export of a country are the basic tools by changing these variables the government of the country can be able to achieve the growth within a stipulated time. In this case, two policies are there in which these macroeconomic variables are used. Additionally, these policies are monetary policy and fiscal policy. In this case, theses two policies are very much important for which the country can be able to bring the stability within the economy (Davig & Gurkaynak, 2015). In this case, each and every economy has their own monetary and fiscal policy so the Australian economy is not the expectation.
2.1 Obtaining data on macroeconomic indicators of Australia
From the site of World Bank the data of interest rate of Australia, unemployment rate of Australia, GDP growth rate of Australia, exchange rate of Australia, the data about export and import of Australia can be found and plotting these data on the excel sheet the charts and diagram can be developed. On the basis of these charts and diagrams, it can be easy to comment on the macroeconomic variable of the Australian economy (Bech, Gambacorta & Kharroubi, 2014).
2.2 Producing summary statistics
year
GDP growth of Australia
1990 [YR1990]
3.529134884
1991
0.38
1992
0.399
1993
4.06
1994
4.038
1995
3.879
1996
3.949
1997
3.947
1998
4.438
1999
5.007
2000 [YR2000]
3.868657682
2007 [YR2007]
3.757657864
2008 [YR2008]
3.706699506
2009 [YR2009]
1.819678261
2010 [YR2010]
2.018182144
2011 [YR2011]
2.379561336
2012 [YR2012]
3.632720303
2013 [YR2013]
2.440049062
2014 [YR2014]
2.499851222
2015 [YR2015]
2.240028575
Table 1: GDP growth rate of Australia from 1990 to 2015
(Source: Data.worldbank.org. Retrieved 15 May 2017)
From the table of GDP growth rate it is clear that there is sustain growth in the Australian economy from the year 1990 to 2015. From the year 2015, the Australian economy was able to maintain stability in the GDP growth rate, which is the indicator of sustainable development in GDP growth rate (Benes et al. 2015).
Year
Interest rate of Australia
1990 [YR1990]
9.641002895
1991
10.063
1992
8.895
1993
8.463
1994
7.984
1995
8.083
1996
6.859
1997
5.87
1998
5.342
1999
6.208
2000 [YR2000]
5.02836016
2007 [YR2007]
3.065919527
2008 [YR2008]
4.180804651
2009 [YR2009]
1.043272004
2010 [YR2010]
6.208688426
2011 [YR2011]
1.460311026
2012 [YR2012]
4.81999084
2013 [YR2013]
6.391280371
2014 [YR2014]
4.473145552
2015 [YR2015]
6.267676605
Table 2: Interest rate of Australia
(Source: Data.worldbank.org. Retrieved 15 May 2017)
From the table it is clear that, there is sustain decrease in the interest rate within the country and it has a positive effect on the Australian economy because lower interest rate means there will be higher investment within the economy (Greenlaw et al. 2013). In effect of this the GDP growth rate will higher and there will be a sustain growth within the country. In the year, 1991 the interest rate has touched the highest rate and in the 2011 the rate of interest was lower and it was 1.46.
Year
Unemployment rate in Australia
1990 [YR1990]
..
1991
9.579
1992
10.729
1993
10.874
1994
9.719
1995
8.469
1996
8.506
1997
8.362
1998
7.676
1999
6.872
2000 [YR2000]
6.282999992
2007 [YR2007]
4.376999855
2008 [YR2008]
4.234000206
2009 [YR2009]
5.56099987
2010 [YR2010]
5.210999966
2011 [YR2011]
5.080999851
2012 [YR2012]
5.221000195
2013 [YR2013]
5.656000137
2014 [YR2014]
6.073999882
2015 [YR2015]
6.059999943
Table 3: Unemployment rate of Australia
(Source: Data.worldbank.org. Retrieved 15 May 2017)
From the year 1991, there is stability in case of unemployment rate there is no sudden increase or decrease in the unemployment rate of the country. Therefore, it is clear that the economy has no such fluctuations in the business cycle (Halevi et al. 2015). From the year 1991 to 1999 there was a increasing trend in the unemployment rate of the country but after this there is an decreasing trend in the unemployment rate of the country.
Year
Inflation rate and CPI of Australia
1990 [YR1990]
7.272260054
1991
3.223
1992
0.986
1993
1.813
1994
1.895
1995
4.638
1996
2.6129
1997
0.25
1998
0.853
1999
1.465
2000 [YR2000]
4.475183076
2007 [YR2007]
2.332361516
2008 [YR2008]
4.352643242
2009 [YR2009]
1.82011224
2010 [YR2010]
2.845225682
2011 [YR2011]
3.303850156
2012 [YR2012]
1.762780156
2013 [YR2013]
2.449888641
2014 [YR2014]
2.487922705
2015 [YR2015]
1.508366722
Table 4: Inflation rate and CPI of Australia
(Source: Data.worldbank.org. Retrieved 15 May 2017)
From this table, it is clear that, within the economy there is no problem of hyperinflation. Therefore, it can be said that the Australian economy is able to earn the stability within the production process though it has some inflation, which is ignorable, and it is required for the growth of the country (Bilbiie, Fujiwara & Ghironi, 2014). After the year, 1990 there was a declining trend in the data of inflation rate and in that year the inflation rate was highest and it was 7.27.
year
Exchange rate of Australia
1990 [YR1990]
1.281056667
1991
1.284
1992
1.362
1993
1.471
1994
1.368
1995
1.349
1996
1.278
1997
1.347
1998
1.592
1999
1.55
2000 [YR2000]
1.724826667
2007 [YR2007]
1.1950725
2008 [YR2008]
1.192178333
2009 [YR2009]
1.28218881
2010 [YR2010]
1.090159486
2011 [YR2011]
0.969463201
2012 [YR2012]
0.965801031
2013 [YR2013]
1.035843097
2014 [YR2014]
1.109363293
2015 [YR2015]
1.331090262
Table 5: Exchange rate of Australia
(Source: Data.worldbank.org. Retrieved 15 May 2017)
In this case, the exchange rate of Australia is lower and from this data table it is clear that, the terms of trade is not ion the favor of Australia. In this case, the Australian economy has to try to earn a favorable terms of trade otherwise, the country will not be able to gain from the exchange rate.
Year
Export of Australia
1990 [YR1990]
15.13786669
1991
16.048
1992
16.672
1993
17.55
1994
17.972
1995
17.881
1996
18.89
1997
19.131
1998
19.594
1999
18359
2000 [YR2000]
19.43613711
2007 [YR2007]
19.89601798
2008 [YR2008]
19.75879946
2009 [YR2009]
22.52445252
2010 [YR2010]
19.44436947
2011 [YR2011]
21.14151348
2012 [YR2012]
21.27942397
2013 [YR2013]
19.82939983
2014 [YR2014]
20.90405143
2015 [YR2015]
19.79747911
Table 6: Export of Australia
(Source: Data.worldbank.org. Retrieved 15 May 2017)
From the data table it is clear that, the Australian economy has a stable export (% of total GDP) and in the year 2009 the export amount has increased but from the year 1990 to the year 2015 there is stable of amount of export within the country.
Year
Import of Australia
1990 [YR1990]
17.12605732
1991
16.246
1992
16.469
1993
17.926
1994
18.505
1995
19.85
1996
19.328
1997
18.82
1998
20.378
1999
20.647
2000 [YR2000]
21.46844087
2007 [YR2007]
21.50655203
2008 [YR2008]
22.35943906
2009 [YR2009]
22.42250244
2010 [YR2010]
20.41599418
2011 [YR2011]
20.10200065
2012 [YR2012]
21.41617361
2013 [YR2013]
21.05979928
2014 [YR2014]
21.39762132
2015 [YR2015]
21.20945901
Table 7: Import of Australia
(Source: Data.worldbank.org. Retrieved 15 May 2017)
From the data table it is clear that, Australian import is higher than the Australian export therefore the earnings from foreign trade is higher in this country. In this case, there is no such fluctuation for import of Australian economy (Halevi et al. 2015).
2.3 Producing pair wise graphs
Figure 1: GDP growth rate of Australia
(Source: Self developed)
Figure 2: Interest rate of Australia
(Source: Self developed)
Figure 3: Unemployment rate of Australia
(Source: Self developed)
Figure 4: Inflation rate and CPI growth rate of Australia
(Source: Self developed)
Figure 5: Exchange rate of Australia
(Source: Self developed)
Figure 6: Export of Australia
(Source: Self developed)
Figure 1: Import of Australia
(Source: Self developed)
2.4 Critically analyzing and discussing plausible economic explanations
In this case, the Australian economy can be able to adopt any one policy or can adopt both the policy on the basis of their requirement. In this case, the Australian economy can take the expansionary fiscal policy by increasing the government expenditure, reducing tax rate the Australian government can take the expansionary fiscal policy. On the contrary, the Australian government can take the contractionary fiscal policy as well where the Australian government will reduce the government expenditure, can increase the tax rate and son in order to achieve the stability within the country (Hossain, 2014). In this regard, it can be said that, if there is an increase in the inflation rate within the country then the Australian government can take the contractionary fiscal policy and additionally if there is an increase in the unemployment rate then the Australian government can take expansionary fiscal policy in order to employ the labor force within the country. In this regard, it can be said that the Australian economy has an objective to achieve the targeted growth rate so the Australian government has to use both the policies within their economy. By the expansionary monetary policy, the monetary authority or the central bank of the Australia can increase the money supply in order to increase the GDP growth rate within the country. In this case, if there is an increase in the inflation rate then by applying contractionary monetary policy the Australian government can reduce the inflation rate from the country. In this case, by reducing the money supply the Australian government can check the inflation rate of the country. In this case, if there is an increase in the inflation rate then the country may not adopt the contractionary monetary policy at first step because a moderate rate of inflation is required for the growth (Adrian & Liang, 2016). In this case, if there is an increase in the inflation rate then it can be said that there will a reduction in the unemployment rate. In this case, the relationship between the inflation rate and unemployment rate can be discussed. In addition to that, it can be said that, there is an inverse relationship between the inflation rate and unemployment rate. However, due to increase in inflation rate there will be a rise in the price level of the economy. In effect of this, the producers of the economy will be attracted in order to maximize profit therefore the producers will employ more labor in order to increase the production within the economy. As a result of this there will be a reduction in the unemployment rate. On the basis of this relationship it can be said that, the moderate rate of inflation is necessary condition for the growth of the economy but the hyperinflation is not required because it has adverse effect on the growth of the country (Halevi et al. 2015).
In this regard, it can be said that the Australian government has taken ten-year enterprise tax plan that is the part of the fiscal policy of the Australian government in the year 2016-17. With the help of this, the Australian government can be able to provide the incentives to the producers and they can be able to generate the employment for the labor force of the country. In effect of this, the Australian government can be able to get the higher GDP growth rate and the employees will be able to earn the wage rate in long run. In order to support the Australian labor force the Australian government has invested $840.3 million on the Youth Employment Packages for which entire labor force of Australia will be able to participate in the production process. In addition to that, the Australian government has invested $50 billion in order to develop the infrastructure within the economy. In this case, there are 100 major projects that are the under construction and 80 projects are there that are the pre construction stage (Aghion, Hemous & Kharroubi, 2014).
Predictions of the macroeconomic outlook of Australia
On the basis of the charts and diagram of the Australian data it can be said that, the growth rate of Australia is not so high but still there is a stability within the GDP growth rate of the country. In this regard, the Australian economy has to be achieved the higher growth yet because the highest growth rate of Australia is 5.07 and it was in the year 1999. Therefore, at least 6 to 7% growth rate is required in the recent economic year and for this an efficient fiscal and monetary policies are required. On the other hand, the interstate rate of Australia has a declining trend that has a positive effect because interest rate and investment has an inverse relationship. Therefore, on the basis of the interest rate of the Australia it can be said that there is an increase in the investment of the country and as a result of this the real GDP of the country will rise (Bech, Gambacorta & Kharroubi, 2014). On the basis of the data of the unemployment rate there is also a declining trend therefore, it can be said that due to increase in the investment there is a reduction in the unemployment rate and for this the Australian economy can be able to move forward to the growth. Based on the data of the inflation rate there is also a declining trend for which it will easier for the country to achieve the growth. In this regard, there is a moderate rate of growth in the inflation rate of the country that helps the country to achieve the growth easily (Fazzari, Morley & Panovska, 2015). On the basis of the exchange rate data of Australia it can be said that the terms of trade is not in favor of Australia for which the country cannot be able to maximize profit from the foreign trade. In addition to that, on the basis of data of export and import of Australia it can be said that, the amount of import is higher in Australia and the amount of export is lower. Therefore, on the basis of the data analysis it can be said that, the Australian economy is not in the developed stage but the Australian government has to adopt more efficient monetary and fiscal policies in order to achieve the sustainability within the GDP growth rate. In addition to that, with the help of these policies the Australian government can protect the economy from any kind of global financial crises (Bilbiie, Fujiwara & Ghironi, 2014).
Conclusion
In this case, all these projects are the part of fiscal policy by which the Australian economy can be able to achieve the higher growth rate and can be able to earn the sustainability within the production process, In effect of this, the unemployment rate of the country; inflation rate of the country will be reduced. In this regard, the Australian economy cannot be able to use fully the fiscal policy in order to earn the stability within the country because the Australian economy has a need to develop and the country has to achieve the higher growth rate otherwise, it will be difficult for the country to compete with the developed country in long run.
Recommendations
On the basis of the data of the Australian economy it can be recommend that:
1. A proper fiscal and monetary policy is required in order to achieve the higher growth.
2. More investment is needed within the country.
3. The Australian government has to spent more money on the infrastructure development.
By following these recommendations, it will be easier for the country to get the sustainability within the country.
References
Bech, M. L., Gambacorta, L., & Kharroubi, E. (2014). Monetary policy in a downturn: are financial crises special?. International Finance, 17(1), 99-119.
Benes, J., Berg, A., Portillo, R. A., & Vavra, D. (2015). Modeling sterilized interventions and balance sheet effects of monetary policy in a New-Keynesian framework. Open Economies Review, 26(1), 81-108.
Greenlaw, D., Hamilton, J. D., Hooper, P., & Mishkin, F. S. (2013). Crunch time: Fiscal crises and the role of monetary policy (No. w19297). National Bureau of Economic Research.
Halevi, J., Harcourt, G. C., Kriesler, P., & Nevile, J. (2015). Post-Keynesian Essays from Down Under Volume II: Essays on Policy and Applied Economics: Theory and Policy in an Historical Context (Vol. 2). Palgrave Macmillan.
Bilbiie, F. O., Fujiwara, I., & Ghironi, F. (2014). Optimal monetary policy with endogenous entry and product variety. Journal of Monetary Economics, 64, 1-20.
Davig, T., & Gurkaynak, R. S. (2015). Is optimal monetary policy always optimal?.
Hossain, A. A. (2014). Monetary policy, inflation, and inflation volatility in Australia. Journal of Post Keynesian Economics, 36(4), 745-780.
Adrian, T., & Liang, N. (2016). Monetary policy, financial conditions, and financial stability.
Aghion, P., Hemous, D., & Kharroubi, E. (2014). Cyclical fiscal policy, credit constraints, and industry growth. Journal of Monetary Economics, 62, 41-58.
Fazzari, S. M., Morley, J., & Panovska, I. (2015). State-dependent effects of fiscal policy. Studies in Nonlinear Dynamics & Econometrics, 19(3), 285-315.
(2017). Data.worldbank.org. Retrieved 15 May 2017, from http://data.worldbank.org/
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FINANCIAL RISK MANAGEMENT
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Executive summary
In this study, the researcher would recommend the management of MML to set strategy of hedging for the loan that the company has taken for financing and the mining stocks of the company. For this purpose, the researcher would analyse the risks, which are involved in the business of the company. The study shall be concluded with the discussion on the selection of strategy on behalf of the company.
Table of contents:
Executive summary. 2
Introduction. 4
Section I. 4
(a) Identification of financial risks faced by MML.. 4
(b) Recommendation for hedging strategy. 5
(c) Recommendation to MML.. 8
Section II. 9
(d) Hedging schedule. 9
(e) Recommendation of TWO option strategies. 10
Conclusions. 11
References. 12
Introduction
In this study, the researcher hall discus the hedging strategy that MML could adopt for mitigating the risk related to the involvement of foreign currency in the business. In the initial part of the study, the researcher shall focus on the identification of the financial risks of the company. After this portion of the study, the researcher shall discuss the requirement of hedging for the sections of business.
Section I
(a) Identification of financial risks faced by MML
As per the case study of MML, the researcher could found that the company has taken a loan of USD 600 millions from a syndicated bank. Along with this debt, the company has also borrowed a variable rate debt of AUD 200 millions. In this context, Ruf (2013) stated that loan at foreign currency involves the risk of foreign exchange as the borrowers are to pay loan through the foreign currency. In this case, MML is to pay the loan at the US dollar. Therefore, the company is to face the exchange rate risk in the time of paying the loan to the bank.
In this case study, it has also been disclosed that the loan of the company has a term of ten years and the interest rate of the loan is floating in nature. In this same context, Norberg (2013) opined that the floating interest rate of loan considers a fixed portion and a variable portion, which depends upon the LIBOR. In this case, the loan has a floating interest rate at 2.5% above the three month US dollar LIBOR rate. Therefore, the company could face the enhancement in the LIBOR rate in future. If the LIBOR rate rises, the company would have to pay a higher amount of interest to the bank.
Apart from the loan in foreign currency, the company has borrowed loan in Australian dollars. The amount of loan was AUD 200 million, which was borrowed at the rate of variable rate. In case of variable interest rate, the lenders are to pay interest on the outstanding balance and the rate of interest is set out by considering the market interest rate (Norberg, 2013). In this context, it is to mention that if the market interest rate enhances, the company would have to pay higher amount of interest. Therefore, the company shall face the interest rate risk as well.
As the company involves in mining business, it is to store and produce mines, which are internationally valued in the US dollar. Therefore, if the price of the outputs of the company decreases in the international market, the company would face loss. Therefore, the foreign exchange rate risk is another crucial risk that could affect the company in near future, as opined by Ruf (2013), a fall in the price of US dollar would result in increase in the gold price and copper price in the Australian dollars. Therefore, the company would face the relative risk of enhancement in the US dollar price in the international market. In addition to that, the researcher is to mention that as the company involves in producing gold and copper, it comprises of risk regarding the change in price of such commodities. This kind of risk of the company could also include in the commodity rate risk. Therefore, the researcher is to mention that the company would face exchange rate risk, commodity rate risk and interest rate risk in operating the mining business in Australia.
(b) Recommendation for hedging strategy
From the above discussion, the researcher could mention that the company would face interest rate risk and the foreign exchange rate risk as the primary financial risks. As stated by Loss (2012), companies could avoid the financial risks by taking proper hedging strategies as hedging strategy minimises the risk regarding interest rate and currency exchange mismatch. In this context, the researcher is to mention that the company could adopt the hedging strategy in order to mitigate the risks, which have been discussed above. In this regard, it is to mention that the company has taken loan in foreign currency, interest rate of which depends upon the LIBOR (London Inter-Bank Offer Rate). Therefore, the company is required to hedge this risk in order to avoid the risk of enhancement in the LIBOR. Therefore, the company is recommended to take the interest rate future as the hedging strategy to minimise the above discussed risk. As the loan has been taken for 10 years, risk of change in the LIBOR is high, and therefore, this risk is required to be hedged by the management of MML.
On the other hand, it is to mention that the company has taken loan of AUD 200 millions at variable interest rate. In this context, the researcher is to mention that the hedging strategy is irrelevant in case of fixed interest rate as the rate of interest is predetermined in fixed interest rate regime (Bodie, 2013). However, the variable interest rate enhances the risk of enhancement of interest burden as the interest rate depends upon the market condition. In this context, Norberg (2013) noted that the interest rate in Australia depends upon the RBA Cash rate as the commercial banks are to borrow fund at the rate of liquid cash rate of Reserve Bank of Australia In this context, the researcher is to mention that the cash rate of Reserve Bank of Australia has shown a decreasing trend over last twenty years (Figure 1). Hence, the company could expect a decline in the Cash Rate in future, and therefore, the company is not required to hedge this risk of variable interest.
Figure 1: Reserve Bank of Australia (RBA) Cash Rate
(Source: Goutte et al. 2014)
In the above part of the research, the researcher has found that the company produces gold and copper, which are valued at the US dollars. Therefore, the researcher is to mention that the change in the US dollar price would affect the profitability of MML in long term. In this context, it is to mention that the enhancement in gold and copper price in terms of the US dollar would be profitable to the company. On the other hand, decline in the gold price and the copper price would result in decrease in the net profit of MML.
Figure 2: Gold price in USD
(Source: Brooks et al. 2012)
Figure 3: Copper price in USD
(Source: Rosenbaum and Tankov (2014)
From the above figure (Figure 2, and 3), the researcher could found that the price of gold and copper have increased over last forty years, and therefore, the company is not recommended to make hedging strategy for the commodity prices.
In this context, the researcher is to mention that as the commodities of the company is traded in the US dollars, MML is to make hedging strategy for the for minimising the exchange rate risk. As stated by Arouri et al. (2015) an increase in the price of USD in terms of AUD would result in super normal profit for the mining companies in Australia. Therefore, it can be said that decrease in the price of US dollar in terms of Australian dollar could be the reason of unexpected loss for MML. in the figure below (Figure 4), the researcher could found that AUD and USD exchange rate has a fluctuating trend. Therefore, the company could face the risk regarding to the exchange rate in future. Hence, it is recommended to the company to hedge the exchange rate risk to minimise the probable future loss.
Figure 4: Exchange rate of AUD and USD
(Source: Gao et al. 2015)
(c) Recommendation to MML
In the above portion of the study, the researcher has seen that the company is to take the hedging strategy to minimise the risk related to foreign loan’s interest and the foreign exchange rate. In this context, the researcher is to mention that the company is required to adopt interest rate future strategy to minimise the risk of the floating interest rate (Chan et al. 2015). In this contrary, Arouri et al. (2012) stated that the companies are to take the interest rate SWAP strategy to mitigate the risk. In this context, the company is to take the strategy of interest rate swap strategy to minimise the risk of floating interest. For this, MML is to make contract with bank to swap the floating interest rate to fixed interest. In this context, it is to mention that the fixed interest rate in Australia is 5% for a term above 5 years (Ruf, 2013). Therefore, the company is to pay interest at the rate of 5% per annum instead of floating interest rate at the rate of 2.5% plus the LIBOR.
On the other hand, the company has been recommended to hedge the exchange rate risks, and therefore, it is to make forward agreement with the bank. In this regard, it is to mention that the company is to make a forward agreement to exchange US dollar at a predetermined exchange rate. This rate is required to be set out by the company. In the time of exercising the forward agreement, the company would have the right to exercise the contract.
In this context, the researcher is to mention that the company would have to pay premium if it takes derivative options such as options and futures. As stated above, the company needs not to take any strategy regarding the risk of enhancement in interest rate in the local market off Australia. If the company plans future strategy regarding the future strategy, it has to pay premium to the bank. As the probability of decline in the interest rate is seen as low, the hedging strategy for variable interest rate is to be considered as irrelevant. If MML takes future strategy to mitigate the risk, it shall pay interest to the bank, which shall result in loss to the company.
Moreover, if the company makes future or option contract for the risk of decrease in the commodity prices, it would have to incur loss as the probability of decline in gold price and copper price is low. Therefore, the researcher has recommended not adopting the future strategy regarding the risk of commodity prices.
In this context, the researcher is to mention that the company is to take the strategy to minimise the risk of exchange rate as the exchange rate of AUD and USD reflected a fluctuation over past decade. The researcher has recommended adopting proper strategy regarding the exchange rate as the company is to evaluate the outputs in the US dollars. For this reason, MML is to make currency forward contract with the bank. As stated by Loss (2012), companies are required to pay premiums while entering into the currency future contract as this kind of contract carries the exchange rate risk. Therefore, the company is to incur the forward premium if it enters into the forward contract. As the fluctuation of the exchange rate of USD and AUD is relatively high, it would be profitable to enter into the currency future contract.
Section II
(d) Hedging schedule
a. Hedging risks:
As per the case study of MML, the researcher has found the interest rate risk and the currency exchange rate risk. In other words, the researcher is to mention that the company is to face the interest rate risk due to the factor that the company has taken a loan at the US dollar and it deals with commodities, which are valued at the USD.
b. Number of futures and/ or options
As stated by Gobet and Landon (2014), the number of contracts could be calculated by considering the fund to be hedged as the numerator and the notional value of contract as the denominator. Therefore, the calculation would be as follow.
-
Interest rate risk
=USD 600/ (AUD 0.74*600*100) = 74
-
Currency exchange rate
= USD 0.74/0.70 = 1
Calculation of number of contracts
Risk
-
Interest rate risk.
-
Currency exchange rate risk.
Futures / or Options
Future
Forward
Number of Contracts
=USD 600/ (AUD 0.74*600*100) = 74
= USD 0.74/0.70 = 1
Contract months
3 months.
4 months.
Long/ short/ Put/ call
Short.
Long.
Strike Prices, premiums/ Futures prices
Strike price = AUD 0.74.
Premium = 2.5%.
Future price= AUD 0.75.
Strike price = AUD 0.70.
Premium = 2.5%.
Future price= AUD 0.65.
c. The contract months
As the current interest rollover is 3 months, the company is to form the contract of interest risk future contract for 3 months. On the other hand, the company is to make the currency exchange forward contract for 4 months as this period is the minimum term of the contract.
d. Position of the contract
In case of the interest rate hedging, the company is to be in short position as the company is to sell the floating interest rate against the fixed interest rate. On the other hand, the company is to be in long position in the forward contract of the currency exchange rate risk as the company would buy foreign currency from bank.
e. Option strike price
In case of future short contract, the company shall consider the strike price of AUD 0.74 against US 1, and in case of the long contract, the strike price would be AUD 0.70 against USD 1.
(e) Recommendation of TWO option strategies
MML faces financial risks regarding the currency exchange rate and the interest rate risks. Therefore, the researcher is required to set strategy to get rid of the financial risks of the company. In this context, if the management of the company wants to set two different option strategies regarding the above mentioned risks, the researcher is to suggest strategy for the currency exchange rate risk and the interest rate risk.
Initially, the company is required to enter in a put option to sell the commodities of the company in the market. As stated by Bodie (2013), companies could make a selling contract through the put option, and this option gives the option buyer the right to sale a commodity or underlying asset to the option seller. Therefore, the company could sell the gold or copper through the option agreement if the price falls below the current spot market.
In the second option plan, the company could enter in a interest rate option, which shall facilitate the company to pay interest at the fixed rate. In this context, it is to mention that the company is to buy a put option to enter in the interest rate derivative market. If the interest rate of LIBOR enhances, the company could exercise the option to pay a lower interest for the loan.
Conclusions
The study has enlightened various aspects of the derivative market in Australia. In the initial part of the study, the researcher has identified that derivative instruments such as futures, options and forward contracts minimises the financial risks. In the next part, the researcher set hedging strategy for MML to minimise the financial risks involved in the business of the mining business. In this part, the researcher has recommended to take forward agreements to mitigate the risks regarding interest rate and currency exchange rates.
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