a)FINANCIAL RISK EXPOSURESMetal Mining Limited (MML) Company is exposed to some financial risks which include; the interest rate risk, the foreign exchange risk, and the commodity price risk (Burghardt, 2003). Interest rate riskThe “interest rate risk” simply means the risk exposure that a portfolio or a company is exposed to as a result of the uncertainty in the “future interest rates”. That is, risk that the value of an investment will vary as a result of a variation in the “absolute level of interest rates”, in the stretch between rates (two) in any “interest rate relationship”Metal Mining Limited has a floating loan facility from a syndicated bank of US$600 million.
This is a five- year loan facility which attracts an interest rate of 2.5% on top of the 3 month US dollar LIBOR (London Inter-Bank Offered Rate) rate. This kind of a loan usually uses indices or other basis of rates in determining the rate of interest to be charged in a given period. For instance, this loan facility will be valued at “six-month LIBOR + 2.50%”. This means that on 30th June, 2011 during the loan rollover the interest rate will be determined by the LIBOR at 1st 2011 – the reset date, in addition to the spread.
Generally, there is uncertainty on the LIBOR and this may cause the overall interest rate to go up. If the interest rate went up then MML will find itself incurring a lot of interest expense which in turn reduces the income of the company. Foreign exchange riskThe “foreign exchange risk” is the risk that the value of an investment will change as a result of changes in the exchange rates of the currency.
That is, the risk of an investor having to incur a loss in the closing out of a short or long position in foreign currencies as a result of an unfavorable movements in the exchange rates. Generally, a foreign exchange risk is said to exist when there is uncertainty regarding the “spot exchange rate” that will prevail in some future time due to variation in the exchange rate (Herring, 1986). This risk commonly affects the exports and or imports a commodity. The sales MML Company of both copper and gold are dominated in US dollars.
MML Company exports its gold and copper to countries like China and India. This means that these countries must convert their currency to the US dollar in order to buy the gold and copper metals. Any variation in the exchange rate of the currency will make the value of the transaction to either increase or decrease when the money is converted into the Australian dollar. That is, MML Company (seller) transactions with overseas business are not expressed in the domestic currency (Australian dollar, AUD) and thus the company is exposed to the exchange risk. Commodity price risk“Commodity price risk” arises in a situation where a company is exposed to variations in the prices of commodity as a part of the operations of the business of the company.
Variations in the prices of the commodity can have unfavorable impacts on the profit margin of the company especially if the increases in costs cannot be charged against the final customer. In this case there is uncertainty regarding the future market value of gold and copper and hence the size of income that will be obtained from their sale in the future (Claessens, 1993).
This is as a result of frequent fluctuations in the price of copper and the price of gold. In the export of gold and copper to other countries like India and China MML company will face risk at the port and at destination market in relation to export license. The company will also face cost risk on the prices of their input (for example, labor), price risk, and quantity risk.