FNM11 Financial Derivatives: Analysis of Investment Risks in Mining

This report provides a comprehensive analysis of the risks associated with a US-based multinational mining company's potential investment in a gold mining project in South Africa. The report identifies various risks, including employee safety and security, social backlash, environmental concerns, emp...Read More

Running head: FINANCIAL DERIVATIVES
Financial Derivatives
Name of the Student:
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Executive summary:
Investment projects provide opportunities to an entity to earn significant return from such
projects in the future provided that investments have been made in profitable projects. The
importance of selection of appropriate investment proposals to invest is huge to the prospect of
an organization. The discussion here shows that there are number of risks associated with
investment projects especially if the project is to investment in a place outside the country where
the entity is looking to invest for the first time. All different risks specific to the investment
proposal along with country specific risks of investing in South Africa have been specifically
discussed to provide the users of these document a clear idea of these risks affecting the
investment proposal.

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Contents
Executive summary:........................................................................................................................1
Contents...........................................................................................................................................2
Introduction:....................................................................................................................................3
Investment project:..........................................................................................................................3
Types of risks underlying the project:.............................................................................................4
Country risks underlying the project:..............................................................................................7
Solutions and recommendations to mitigate and manage these risks:.............................................9
Conclusion:....................................................................................................................................11
References:....................................................................................................................................12

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Introduction:
Investment in different countries from the country of origin of an entity presents number of
different risks and challenges. The political and social environment of a country is completely
different from another. In addition economic environment, financial environment, operational
environment and even the natural environment of a place is completely different from another.
There are number of challenges such as difference in rules and regulations governing business
law in a country, the cultural differences, difference in weather, difference in tax rules and
others. All these must be considered by an entity before deciding on investment in a place
outside the country of its origin. The purpose of this document is to discuss the risks associated
with the investment project in South Africa.
Investment project:
A US registered multi-national company conducting mining operations with annual turnover of
$0.5 billion is looking to invest in South Africa with the potential cost of investment of $125
million. The entire cost of investment is sunk cost and not recoverable as per the information
provided in the document. In order to finance the project the company has decided to take a bank
loan from US. The loan shall carry an annual interest rate of 8% with the expected life of the
project is 10 years the loan will also be repaid during this period. As per the initial assessment by
the management the company expects to earn a positive net present value of $18,607,407 from
the project. However, since there are number of different risks associated with investment in a
country different from the one in which an entity is based and mainly operates, a detailed
discussion regarding the possible risks are explained here.

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Types of risks underlying the project:
The company is a mining company involved in mining operations in the US is looking to invest
in gold mining project in South Africa with initial cost of $125 million. Risks specific to the
project is discussed here. There are number of risks specific to the gold mining project, these are
as following.
Risk of employee safety and security:
Mining industry has a separate safety and security standards for their employees and workings.
Especially those who works in the mines and involved in mining operations directly. The risk of
employee safety and security in the mines possess very credible threat to a mining company and
this is true even for gold mining. The company should be careful of this risk as the safety and
security of mine workers and employees must be given due importance in the overall strategy of
the company (Formation Fragmentation Modeling and Impact on Dragline Excavation
Performance in Surface Mining Operations, 2019).
Risk of social backlash and protests:
Environmental groups in all across the globe have protested against the mining activities to stop
mining in different places around the globe. This is a very specific risk, associated with different
types of mining including the mining in the gold sector. It is important for an entity to consider
the extent of threat this risk provides to the investment proposal in South Africa. It is important
to make all arrangements to deal with this risk as the risk has the potential to derail an entire
investment project. Thus, the management must consider the implications of risk of protests and
social back lash specific to the investment project.
Environmental risk:

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As compared to any other types of business operations the environmental risk associated with the
investment project of mining is significantly high. This is simply due to the nature of operations
necessary to extract metal or other materials from mines. In case of gold mining also the effects
of mining on the environmental as a whole shall be considered and necessary steps must be taken
to ensure that the harmful effects of mining on the environment is reduced to minimum. The
importance of environment risk in the overall mining operations in relation to the gold mining is
critical to the success and failure of such investment project (Verma and Gupta, 2013).
Employee health related risks:
The health of the employees is again a great concern for mining industry. The employees
working in the mines are exposed to number of threats that affect their health negatively. Due
consideration must be given to the health risks associated with the workers and employees
working in the mines. From unbearable noise to exposure to harmful chemicals within the mines,
there are number of risks to the health of the employees and workers. This is specific to mining
operations and must be considered by an entity while deciding to invest in mining project (Meng,
2018).
The extent of mining allowed by the government in specific mines:
The mining operations have number of restrictions such as maximum length up-to which mining
can be carried out. The government that gives license of mining also specifies the extent of
mining that must be carried out and beyond which no mining shall be allowed. An entity must
assess the expected performance of the investment project by considering the extent to which
mining is allowed. Based on that necessary assessment must be made before determining the
business prospect of investing in the mining project.

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Access to energy and use of energy:
The requirement of energy in mining operations is huge thus, the extent of energy required for
gold mining is always an important consideration for a new mining project. The required amount
of energy must be present for the mining activities to continue. Thus, it is important to take all
due care before deciding whether to invest in a project that has such large requirement of energy.
Thus, the risk of access to the energy is always an important consideration for an entity to take
important mining decisions. Lack of energy will be extremely dangerous for an entity to operate
in the mines thus, the risk of access to energy must be considered and given due importance
(Michaels, 2014).
In addition to access to energy the risk of making use of such energy is always present in mining
operations. The risk of improper and ineffective use of energy will lead to huge amount of
expenditures to continue mining operations leading to accumulation losses to the business.
Regulatory risks:
The risk of rules and regulations is a very genuine risk for any new business. In case of an entity
starting its mining operations in a different country all together the regulatory risks associated
with such operations is even more complex. Such risk must be considered and included in the
overall assessment of a project. In case of gold mining there are number of rules and regulations
such as the safety measures to be used within the mines, the extent of mining allowed, the
pollution control equipment to be installed within and outside mines to reduce the harmful
effects on the environment etc. These factors shall be considered and accounted for while
deciding on the investment proposal and its suitability.
License risk:

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The risk of obtaining license of mining for the mining operations is another important factor to
be considered while taking important decision such as investment in a new mining project. The
ability to obtain license is often dependent on the past record of an entity in mining operations
and its project outline. Thus, the risk of obtaining a license for mining must be considered and
included while assessing the overall risk of mining.
Rising costs of mining:
The cost of mining is rising continuously. This is a very genuine risk to the mining business and
must be given due consideration while determining the extent of risk associated with mining
operations in the new investment project (Michaels, 2014).
Country risks underlying the project:
South Africa is a place where there have been a history issues associated with the cultural
diversity, ethnicity and political instability. Though with passage of time the country has
changed to be more business friendly but the specific risks associated with the mining operations
in the country must be considered and given due importance.
Political instability:
South Africa has seen number of dictators that has ruled the country for years. However,
democracy has been established in the country for years now. The political instability of past is
long gone. However, while investing in a new project the management should consider even the
miniscule risk of political instability in the country (Dev, 2013).
Cultural and ethnic difference:

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As compared to US there is significant difference in culture and ethnicity in South Africa. The
risk that differences present to an investment project shall also be considered and given
necessary importance.
Legislations and rules:
The legislations and rules of business in the country along with specific legislations for mining
shall be assessed and included in the assessment of overall risks associated with mining business
in the country.
Government interference:
The level of government interference in business is different in different places. Compared to the
US the governance interference in business operations in South Africa is extremely high. The
risk of such government interference must be considered while assessing the overall risk of
investment in the project (Samavati, 2019).
Foreign exchange risk:
The risk of foreign exchange exposure. Considering that the sales contract are to be set in pound
sterling the risk of foreign exchange exposure is a realistic threat to the company. The impact of
fluctuation in foreign exchange rate, i.e. US $ to pound sterling must be considered before taking
final decision on the matter of investment in the mining project in South Africa (Durčáková,
2011).
Tax rules:
The taxation rules in different countries are different. It is important for a business to assess the
tax implications on the revenue and profit from the business operations in a country to determine

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the desirability of investing in that country. Similarly, the tax rules applicable for the mining
business in South Africa shall be considered and included in the assessment of business risk.
Social and environmental groups in the country:
The social and environmental groups in a country and its influence on business operations are
another important factor to the overall assessment of an investment proposal and its desired
outcome.
Solutions and recommendations to mitigate and manage these risks:
In order to mitigate the risks identified that are specific to the business of the mining company as
well as specific to the country of operations, following solutions and recommendations shall be
extremely effective.
Conducting a thorough investigation of mining prospect in the area of operations:
The company firstly needs to conduct a detailed investigation on the mining prospect in South
Africa. This will enable the management to understand the probable outcome of investment in
mining operations in the country (Turner and Gianiodis, 2017).
Assessment of possible risks associated with the health and safety of employees and workers in
the mines:
There are number of risks to the health and safety of employees in the mines. The company
should conduct a thorough assessment of all these risks and take appropriate steps such as
instituting pollution control equipment within the mines, making necessary arrangements within
the mines to reduce the toxic environment within the mines, making sure there is proper air
flowing system within the mine, providing the employees and workers with safety gears, keeping

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paramedic system in place within and outside the mines and others. These steps will help in
ensuring that the health and safety of the employees and workers are given due importance and
emphasis (Voss, Witthaus and Junker, 2013).
Obtaining license:
Obtaining proper mining license from the government authority is important to the mining
operations. Thus, the company shall firstly obtain necessary license to start mining operations in
the country.
Complying with the requirements of license:
The company should comply with the license requirements to ensure there is no problem in
renewing the license for the mining operations in the future.
Complying the legislations governing mining and business operations in the country:
The company should ensure that all the rules and regulations governing the mining operations
and business operations in the country are complied with to avoid any penal provisions. There
are number of requirements such as proper filling of required documents with appropriate
government authorities on or before the due time to ensure that each and every single
provisio0sn of the act and legislations have been followed (Ashraf and Arshad, 2017).
Using advanced and modern technology:
Use of advance and modern technology will help the company to reduce the pollutions from
mining operations. The company should install necessary pollution control equipment and use
such measures to reduce the pollution from mining operations (Berengueres, 2018).

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Stop mining before the danger level approaches:
Stopping mining operations significantly earlier before the danger level approaches is essential to
the safety and security of workers, employee in the mines and for the environment as a whole.
Strict measures shall be used to ensure that mining operations are stopped before even the danger
level approaches (Yadav and Jamal, 2016).
Using capital budgeting technique:
Use of capital budgeting technique shall be made to assess the profitability of the project before
taking final decision of investment in the project. All the assumptions and fluctuations shall be
included in computation of net present value from the investment project to determine the
desirability of the project (Srithongrung, 2017).
Use of forward and future rate contracts:
In order to mitigate the risk of fluctuation in foreign exchange rates the company can use forward
rate and future rate contracts depending on the circumstance and situation. Forward and future
rate contracts will allow the company to reduce the loss on foreign exchange fluctuations.
Conclusion:
Taking into consideration the net present value of the investment project in South Africa of
conducing gold mining, i.e. $18,607, 407 (positive) thus, there is no reason to not invest in the
project. However, as mentioned earlier that all the risks associated with the investment project
shall be thoroughly analyzed and included in the assessment of the project to determine the
expected outcome of the project. In this case the financial implications of the project has been
assessed from the net present value of the project which is positive however, other risks

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mentioned here shall also be given due importance before deciding on the suitability of the
proposal to invest in the project.

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References:
Ashraf, B. and Arshad, S. (2017). Foreign bank subsidiaries’ risk-taking behavior: Impact of
home and host country national culture. Research in International Business and Finance, 41(48),
pp.318-335.
Berengueres, J. (2018). Valuation of Cryptocurrency Mining Operations. Ledger, 3(7), pp.19-
274.
Dev, D. (2013). A Study on Mining Industry Pollution in Chapagaon, Nepal. Environment and
Pollution, 2(4), pp.7-10.
Durčáková, J. (2011). Foreign Exchange Rate Regimes and Foreign. Exchange Markets in
Transitive Economies. Prague Economic Papers, 20(4), pp.309-328.
Formation Fragmentation Modeling and Impact on Dragline Excavation Performance in Surface
Mining Operations. (2019). International Journal of Mining Science, 5(1), p.17.
Meng, Q. (2018). Rethink potential risks of toxic emissions from natural gas and oil
mining. Environmental Pollution, 240(hlms), pp.848-857.
Michaels, R. (2014). Letter from the Guest Editor: Introduction to the Special Topic:
Environmental and Public Health Risks Associated with Climate Change. Environmental
Practice, 16(1), pp.2-3.
Samavati, M. (2019). Production Planning and Scheduling in Mining Scenarios Under IPCC
Mining Systems. Computers & Operations Research, 2(2), pp.12-39.

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Srithongrung, A. (2017). Capital Budgeting and Management Practices: Smoothing Out Rough
Spots in Government Outlays. Public Budgeting & Finance, 38(1), pp.47-71.
Verma, S. and Gupta, M. (2013). Risk assessment in mining industry. International Journal of
Mining and Mineral Engineering, 4(4), p.312.
Turner, T. and Gianiodis, P. (2017). Entrepreneurship Unleashed: Understanding Entrepreneurial
Education outside of the Business School. Journal of Small Business Management, 56(1),
pp.131-149.
Voss, H., Witthaus, H. and Junker, M. (2013). Plough longwall operations under challenging
geological conditions. Mining Report, 149(S1), pp.5-16.
Yadav, A. and Jamal, A. (2016). A Review on the Present Scenario of Air Quality Associated
with Indian Mining Operations. Environmental Quality Management, 25(3), pp.99-105.