Barrick

Q. 1

The answer  to the question of weather to hedge depends on a number of factors.

1. Exposure to currency fluctuations. If a company operates in multiple regions and receives dividends in different currencies it might be a good idea to hedge. For example, a company invests in dollars and plans certain  level of returns in dollars. In case of depreciation  of local currency it will have less dollars to distribute. The decision to hedge in this case will depend on volatility of exchange rate between two currencies, degree of exposure, market to which a  subsidiary operating in a different geography sells it`s products (external or internal).
2. Exposure to price volatility. Companies trading commodity goods who`s price are determined by global demand and supply are exposed to macroeconomic risks.
3. Exposure to change in interest rates. For companies which have some amount of debt and who`s assets are dependent on fluctuation in interest rates hedging creates a good option to mitigate losses.
4. Exposure to volatility in demand. For example, in high-tech companies the cycle of goods is short as they become obsolete in a quick span of time. Thus, companies are exposed to fall-downs in demand and revenue if they are not able to market innovative products.

Hedging does not only provide companies with opportunities to avoid financial distress but opens options to preserve and create value. But done poorly it can destroy value. Below are some disadvantages and risks that come with hedging.

1. Hedging is costly which pertains not only to direct costs but also to indirect costs such as opportunity costs of margin capital.
2. Lower stock price. In the event gold prices rise beyond the forward price, theory holds that the stock price will be lower than otherwise because the producer’s earnings/revenue stream will be lower than otherwise.
3. Wrong hedging strategies. For example, gold-mining executives have proved over and over again that when it comes to the timing of their hedging moves, they are the proverbial dumb money. They get scared and put hedges in place following a large price decline and then get pressured into removing the hedges at great cost following a large price rise.
4. Failure to apply hedge accounting. The business might enter into the right set of hedges that reduce cash-flow risk but actually increase its earnings at risk, because of the volatility of the derivative showing up in earnings per share.
5. Overselling output forward. If a producer cannot deliver the agreed amount of gold on due date the producer must buy gold in the market and deliver that to the bullion bank. If the market price of gold in higher than that indicated in the forward contract this produces incurs a loss.

Advantages of hedging.

1. Guarantees predictable levels of cash flow. Hedge instruments protect companies by guaranteeing minimum levels of cash flow and making their investment programmes more viable in bad times.
2. Guarantees predictable level of production. This is especially valuable in cyclical industries where the cost of conservation of production and further renewal is high.
3. Protects the downside in case of fall in price.  
4. Allows to specialize in gold production instead of managing risks.  
5. Allow companies to maintain certain level of leverage.