Risk Management Consulting Report to Elite Copper Corporation

Running head: DERIVATIVES 1
Risk management consulting report to elite Copper Corporation
Student’s name
Name of the university
Author’s note

DERIVATIVES 2
Executive summary
This paper is a short consultation report to Mr Richard Morris and the elite copper
corporation. It is specifically a risk management report written in response to the raised points of
concern. The report covers aspects regarding the potential risks that the copper corporation is
likely to encounter while pursuing the intend decisions to increase its cash flows, company size
and valuation. Therefore the report highlights the various aspects of concern that need to be
critically assessed and analyzed before undertaking such decisions. Within the report, alternative
possible strategies that have to be undertaken are covered. These will be used guidelines or areas
of references when making company decisions. The report covers definitions and explanations of
important terms and concepts. All such explanations and elaborations are aimed at providing a
more informed
Introduction
The risk management report written to elite Copper Corporation is a guiding document
providing an insight into the aspects surrounding derivatives. The report goes further to provide
more detailed knowledge and understanding the types of risks that the company is exposed to.
The general discussion of the report, therefore, focuses around risk management strategies, the
positions to be taken by the firm in the copper mining industry, identifying these risks as well as
their impact on the firm. A risk is a possibility of or presence of a chance of losing something of
value. It can, therefore, be through damage, injury, liability and any other negative deviation
from the anticipated or intended result. In terms of finance, therefore, risk refers to the possibility
that a return on an investment will be lower or less than the expected return. Financial risk is
therefore subdivided into different categories. These may include risks such as capital risks,
economic risks, liquidity risks reinvestment risks and so many other types of risks. This report
will, therefore, provide explanations concerning some of the above types of risks as required for
better decision-making purposes.

DERIVATIVES 3
Discussion of the report
The futures and position that elite copper should use when hedging against exposure
Futures are derivative financial agreements the give contracting parties the duty to trade
or carry out transactions on a given asset or security at a specified future point in time and price.
When dealing with futures, the buyer or seller is obliged to either purchase or sell the asset at an
agreed price at the time of maturity. This, therefore, eliminates the possibility of refusal to buy or
sell at the maturity date in the futures market. The futures market, on the other hand, refers to an
auction or bid market through buyers and sellers trade commodities at predetermined prices at
maturity. The futures market includes the New York mercantile exchange, Kansas City Board of
trade, the Chicago mercantile exchange among others (Chen, 2019).
Among the possible types of futures that the firm can take include the equity futures. The
most immediate futures that elite copper should trade-in are the copper futures, equity futures are
as well an important alternative that the company can use when hedging against future risk.
Because the copper market prices are highly volatile, elite Copper Corporation needs to
effectively protect against possibilities of unfavourable price fluctuations. Equity futures act as a
protective strategy by creating high leverages to the firm. Additionally, equity futures would
provide the company with an option to choose a position before markets are opened or closed.
Elite Copper Corporation should use financial futures such as the US treasury futures (Hargrave,
2019). The benefit associated with using such futures is that the dollar is a global currency that is
used on a global scale. Furthermore, because the dollar is a relatively stable currency, the firm is
relatively safeguarded from the highly volatile market conditions within the metals market. This,
therefore, implies that the value of the firm’s commodity on the financial market is safeguarded
from risks arising out of price volatilities. Since elite Copper Corporation is seeking to safeguard
itself from prices volatilities, and because it is a mining company, the futures position it can take
is short. The short position, therefore, means that elite company will enter into a futures contract
with any other buyer. The short futures position is, therefore, the act of entering into a binding
contract for the sale of a commodity item at a predetermined price at maturity. Therefore, the
short position would require Elite Corporation to sell copper to a buyer at an agreed price in the
future.

DERIVATIVES 4
Optimal hedge ratio
The minimum variance hedge ratio is also known as the optimal hedge ratio is a method
that is used to evaluate the correlation between the variance in the value of an asset or liability
and that of the instrument used for hedging (Chen, 2019). This concept is commonly used by
businesses or by investors to protect against threats and exposure. However, since there is no
perfect hedge, financial analysts need to calculate and determine the least variable optimal
hedge. This is specifically carried out to create a tradeoff between the existing exposure to risk
and possible alterations in the value of the underlying security at hand (Sehgal and
Agrawal,2019). Therefore, the formula for determining and calculating the optimal hedge is
given as follows:
h = ρ . σs
σf
Where: h represents the optimal hedge,ρ stands for correlation∧σ is the standard deviation. S is
the spot market price and f is the future market price.
According to the Chicago Mercantile Exchange market, the spot closing and open market prices
are $ 2.6245 and $ 2.6140. The December prices of copper futures are however given as $
2.6315 for the opening and $ 2.6420 for the closing mark. The December prices are used as the
spot prices whereas the December prices are used as the future quotations for this particular task.
It is these prices that are used for calculating the standard deviation of the copper futures when
finding the hedge ratio or optimal hedge.
Assuming that there is a high degree of correlation between the copper futures and copper, the
correlation would, therefore, be about 0.95. And that the spot and future standard deviation of the
in the prices on the market is about 0.3%. Hedge ratio would be 0.95 = 0.95( 0.003
0.0 03 ).
This method is an important approach that can be used in determining the highest number of
futures agreements that can be bought to acquire a hedge position (Kantox, 2017). This is