Solution Library

Objectives When Formulating a Risk Management Strategy

Question

Suppose you are advising a gold mining firm on risk management strategy.  It has a mine capable of producing ten ounces of gold per year.  This year, the firm plans to produce 10 ounces.  The firm’s cost of production in $1200 per ounce, which it is committed to paying at the end of the year.  The firm has $1000 cash and no access to other sources of external financing.  If it fails to meet its production target, it loses its factory and future rights to produce.  The lending rate is zero percent.

  • What objective would you target for this firm when formulating a risk management strategy? In other words, what outcome are you trying to achieve or avoid?
  • Consider the derivatives discussed in class: 1) forwards, 2) calls, and 3) puts. Assume the underlying in each case is gold.  For each derivative, identify the direction of the position (e.g., long or short) that you would take to manage risk in this situation (assuming that the firm is in fact able to buy the derivative, if a premium is necessary).
  • Suppose the only derivative available is a one year call on gold with strike price 1500. It is priced at $100 per ounce.  Could you use this derivative to help you accomplish your goal in a)?  How?  Also, describe the circumstances, if any, under which your strategy would accomplish your goal, and those, if any, under which it would fail.
  • Suppose now that, in addition to the call described in c), there is also a one year put option on gold with strike price 1100 that is priced at $100. Is there a risk management strategy for the firm that will fully protect against bankruptcy?  Describe it.  

 

 

Download Full Solution

Comments

  • HWA
    Rasha

    this is a very good website

  • HWA
    maani

    I have 50 questions for the same test your page is showing only 28

  • HWA
    joeanne

    hi can you please help or guide me to answer my assignments. thanks

  • HWA
    joeanne

    hi can anyone help or guide me to my assignments. thanks

  • HWA
    Monik


  • HWA
    Cristina

    This solution is perfect ...thanks

  • HWA
    Janete

    Hello Allison,I love the 2nd image that you did! I also, had never heard of SumoPaint, is something that I will have to exolpre a bit! I understand completely the 52 (or so) youtube videos that you probably watched. Sometimes they have what you want, sometimes they don't! However, it is always satisfying when you are able to produce something that you have taught yourself. Great job!Debra 0 likes

  • HWA
    Sandeep

    Perfect bank of solution. 

  • HWA
    Oxana

    great !

  • HWA
    Paul Brandon-Fritzius

    thanks for the quick response. the solution looks good. :)

  • HWA
    tina Johnson

    thnx for the answer. it was perfect. just the way i wanted it. 

  • HWA
    Giuseppe

    works fine.