The effect of gold price changes on Barrick stock is hard to correctly measure and it is even harder under the hypothesis of no hedging program. There are many papers studying the sensitivity of Barrick stock to gold price changes, however, very few (probably none) have calculated it with the elimination of hedging program. For instance, Petersen and Thiagarajan(2000) valuate the hedging program by comparing impact of gold price changes to ABX stock and that to Homestake Mining (no hedging).
We Will Write a Custom Essay Specifically
For You For Only $13.90/page!
By creating a CAPM model, they find that while ABX’s equity returns rise 16% for every 10% increase in gold price, Hometake Mining’s is slightly higher at 17%. Tufano (1998) does a similar model but just for ABX, he finds that for every 1% increase in gold price, its stock price increases about 3%. With the elimination of hedging program, it becomes much more complex to measure the sensitivity since the effects of this hypothesis can never be fully covered. We have to make some assumptions. Firstly, Barrick stock is linearly related to its equity.
Secondly, the only change, from the absence of hedging program, is the deduction of the gains or losses the program has created. Using the actual and realized gold prices in exhibit 12, we work out the difference of profit between hedging and not. We find that the sensitivity of Barrick stock to the changes in gold prices is 5. 1 (see appendix). This is much higher than those found by the above papers. The reasons might be (1) the assumptions are quite unrealistic, (2) the effects of the hedging program very much stabilises the stock against to changes in gold prices. Effect of 1% change in gold price to Barrick stock Therefore, for every 1% change in gold prices, it is estimated from our model that Barrick stock might change by 5. 1%.
However, there always a limit for the changes, i. e. the 1% change in gold price can never always result in a constant 5. 1% in ABX stock. For example, if the stock price is already very high, it can be more reluctant to rise compared to a low stock price as gold prices change. Alternatives to risk management by financial contracts In stead of using financial contract to manage risk, firms can apply other techniques. According to Merton (1993), they could diversify their production instead of hedging or insuring.
Although to change production, mining firms faces many difficulties, they can still diversify their locations (mining in America, South Africa or Australia); they can also exploit other metals such as silver, aluminium, etc. In addition, they can adopt conservative financial policies such as maintaining low leverage or carrying large cash balances to protect themselves against potential hardship. In practice, there are a few firms choosing this type of hedging such as Hometake Mining and Battle Mountain. It is however, quite costly and low effective; therefore, many choose financial instruments for their risk management.