Financial Risk Analysis and Management Report for OZPRTS Co.

This report examines the financial risks faced by OZPRTS Co., focusing on managing aluminum price volatility and currency exchange rate fluctuations. It identifies the company's exposure to USD for aluminum purchases and analyzes the variability of aluminum prices and the AUD/USD exchange rate from 2015 to 2018. The report evaluates derivative-based hedging strategies, including futures and options contracts, to mitigate these risks. It uses diagrams to illustrate these hedging techniques, identifies potential problems with their implementation, and recommends specific hedging instruments for aluminum purchases and currency exposure related to engine casing sales. Furthermore, the report identifies the currency exposure on the revenue side for OZPRTS Co. and discusses the conditions under which exposures may act as an offset.

Running head: MANAGING FINANCIAL RISK
Managing Financial Risk
Name of the Student:
Name of the University:
Authors Note:

MANAGING FINANCIAL RISK
1
Table of Contents
a) Identifying and discussing the exposures that OZPRTS Co. faces over the next three years:
....................................................................................................................................................2
i) Identifying the currency in which aluminum is priced and stating the exchange rate
OZPRTS Co. is exposed due to purchase of aluminium:...........................................................2
ii) Collecting data and discussing variability on both aluminum prices and appropriate
exchange rate:.............................................................................................................................3
iii) Depicting the exposure of OZPRTS Co. on purchases of aluminium and exchange rate:...5
b) Critically evaluating the use of option or futures to hedge against the risk that OZPRTS
Co. faces from the purchase of aluminium:...............................................................................6
i) Using the appropriate diagram to identify derivative-based hedges on the cost of aluminium
and the relevant exchange rate:..................................................................................................6
ii) Identifying and explaining problems that might be faced by derivative-based hedging
strategies:....................................................................................................................................9
iii) Choosing one the derivative-based hedge instruments for each of the exposure of
OZPRTS Co.:.............................................................................................................................9
c.i) Identifying the currency exposure on revenue side that is faced by OZPRTS Co. on its
sale of engine casings:..............................................................................................................10
c.ii) Choosing whether to use option or futures hedge against currency exposure that
OZPRTS Co. conducts:............................................................................................................11
c.iii) Discussing the conditions under which the exposure may act as an offset:....................12
References:...............................................................................................................................14

MANAGING FINANCIAL RISK
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a) Identifying and discussing the exposures that OZPRTS Co. faces over the next three
years:
i) Identifying the currency in which aluminum is priced and stating the exchange rate
OZPRTS Co. is exposed due to purchase of aluminium:
From the overall evaluation, the prices level of aluminum could be identified, which
trades in USD in the global market. In addition, USD is the major accepted current, which
has been used after the demise of GBP, as the world currency after world war 2. Moreover,
the aluminum market mainly trades in USD, which increases the exposure of OZPRTS in
USD currency. Therefore, OZPRTS needs to increase their exposure in USD/AUD trading
for conducting relevant trades in commodity market. In this context, Li, Ng and Chan (2015)
stated that the exposure of currency market needs to be maintained by adequate hedging
process, which helps in reducing the volatility from the currency market. However, OZPRTS
needs relevant aluminium in the current pricing to fulfil the commitment of producing
200,000 aluminium transmission casings per annum. Hence, it could be understood that
OZPRTS needs to increase its exposure in USD, which is used to trade aluminium in the
global market.

MANAGING FINANCIAL RISK
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ii) Collecting data and discussing variability on both aluminum prices and appropriate
exchange rate:
1-Mar
1-May
1-Jul
1-Sep
1-Nov
1-Jan
1-Mar
1-May
1-Jul
1-Sep
1-Nov
1-Jan
1-Mar
1-May
1-Jul
1-Sep
1-Nov
1-Jan
1-Mar
1,300.00
1,500.00
1,700.00
1,900.00
2,100.00
2,300.00
2,500.00
Allumunium Close
Figure 1: Depicting the Aluminum price from March 2015 to March 2018
(Source: Au.investing.com 2018)
The above chart mainly helps in depicting the oval aluminum prices from March 2015
to 2018, which provides an in-depth price movement of the commodity within the range of
three years. In addition, the evaluation of chart mainly depicts the rising price of aluminum in
the global market, which is due to the high demand of the commodity with in the automobile
industry. From the overall evaluation the prices of aluminum have increased by 12.34% in 3
years, which directly indicates the demand of the community with the consumers. In this
context, Renz and Herman (2016) stated that use of hedging measure could also companies to
reduce the excess cost of their community, which is used in their production system. The
current price of aluminum has relevantly increased over the period of 3 fiscal years, which
indicates the relevant loses that might incur by the company. The rising prices of aluminum
in the period of three year depicts an estimation of future prices, which could increase due to
the continuous demand of the commodity in the international market.

MANAGING FINANCIAL RISK
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1-Mar
1-May
1-Jul
1-Sep
1-Nov
1-Jan
1-Mar
1-May
1-Jul
1-Sep
1-Nov
1-Jan
1-Mar
1-May
1-Jul
1-Sep
1-Nov
1-Jan
1-Mar
0.68
0.7
0.72
0.74
0.76
0.78
0.8
0.82
AUD/USD Close
Figure 2: Depicting the AUD/USD price from March 2015 to March 2018
(Source: Au.investing.com 2018)
The above figure mainly depicts the overall volatile currency validation of
AUD/USD, which has strengthened over the period of three years. The AUD has gained
ground over USD, which it lost within the period of 3 years. This relevantly indicates that
current trend of AUD/USD might increase the chance of loss, which might increase profits of
the company. In addition, from the overall evaluation it could be understood that value of
AUD/USD over the three period is at the level of 0.95%. This indicates that steadily USD has
increased its valuation against AUD, which raises the level of expenses that will be
conducted by the company for obtaining aluminum commodity for its production process.
Hillson and Murray-Webster (2017) argued that without the evaluation of current market the
trades conducted for hedging against the volatility exposure can hamper the actual financial
performance of the company. The combination where aluminum pricing rises in valuation
and USD strength increases in comparison to AUD directly affects the actual cost of
aluminum over the period.

MANAGING FINANCIAL RISK
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iii) Depicting the exposure of OZPRTS Co. on purchases of aluminium and exchange
rate:
1-Mar
1-May
1-Jul
1-Sep
1-Nov
1-Jan
1-Mar
1-May
1-Jul
1-Sep
1-Nov
1-Jan
1-Mar
1-May
1-Jul
1-Sep
1-Nov
1-Jan
1-Mar
1,700.00
1,900.00
2,100.00
2,300.00
2,500.00
2,700.00
2,900.00
3,100.00
Allumunium Price in AUD
Figure 3: Depicting the Aluminum price in AUD from March 2015 to March 2018
(Source: As created by the author)
The above figure mainly depicts the overall expenses of the company, which could be
conducted over the period of three fiscal year from March 2015 to 2018. In addition, the price
of aluminum on USD has relevantly increased over the period of three fiscal years, as
depicted in the above figure. The calculation is mainly conducted to understand the actual
change in prices of commodity over the period of three fiscal year. This could help the
company understand the relevant changes in cost, which needs to be conducted when trading
aluminum and completing the manufacturing process. Kendrick (2015) stated that companies
with the help of currency valuation can detect increment in price of their commodity, which
will incur during the fiscal year. On the other hand, Rubin et al. (2017) criticizes that this
continuous rising price through currency volatility might hamper profit of the organization.
Therefore, OZPRTS could adequately use hedging measure for reducing the relevant
exposure in the commodity market and currency market. The prices of aluminum in AUD has

+$
-$
Decrease in price
Current price
Increase in price Long Futures
Short Futures
MANAGING FINANCIAL RISK
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relevantly increased from 2,.345.87 to 2,610.69, which indicates high demand of the product
over the time.
b) Critically evaluating the use of option or futures to hedge against the risk that
OZPRTS Co. faces from the purchase of aluminium:
i) Using the appropriate diagram to identify derivative-based hedges on the cost of
aluminium and the relevant exchange rate:
There are three types of derivatives-based hedges, which could be used for
commodity purchases that is needed by the company over the period of three years. In
addition, the hedges are depicted in diagram format over the period of time.
Futures contract:
Figure 4: Depicting diagram for future contract
(Source: As created by the author)

Loss limited
Profit Unlimited
Strike price
Long Call
MANAGING FINANCIAL RISK
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The above diagram mainly depicts the overall payoff and layout of future contract,
which could be used by the company to hedge its exposure in the market. Future contracts
mainly help in reducing the risk from investment, which could generate high level of returns
from investment. Therefore, with the help of future contract companies are able to reduce the
risk from changing volatile commodity prices and fix their actual cost for the purchase. this
helps in maintaining the level of returns and profits that is estimated by the organization
before commencing the production. Hence, with the help of future contracts aluminium
purchases can be conducted adequately by fixing the price of the commodity before the
Purchase date. This could help the company to reduce the excessive burden on capital, due to
volatile prices of aluminium. The spread generated from future contract would eventually
help in reducing the excessive cost of aluminium by purchasing the product from the
international market. Pfaff (2016) stated that with the help of futures contract companies can
hedge their exposure in the commodity market by fixing the overall purchase price and
reducing the negative impact of price volatility.
Option Contract:

Loss
Profit
Strike price
Long Put
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Figure 5: Depicting diagram for option contract- Long Call
(Source: As created by the author)
The above contract depicts the option hedging process that could be used by
organizations to fix its overall purchase of aluminum commodity. The contract could
eventually help in reducing the excessive prices of aluminum in the international market by
using hedging measures. The option contract would eventually help in going the loss that
might be incurred by the company due to the changing prices of aluminum in the
international market. Brooks (2015) mentioned that option contracts mainly help
multinational corporations to conduct hedging process by providing below premiums on the
trade in comparison to future contracts.
Figure 6: Depicting diagram for option contract- Long Put
(Source: As created by the author)
The long-put option diagram is represented in the above figure, which could be used
for hedging the overall currency exposure that is faced by OZPRTS. In addition, this contract

MANAGING FINANCIAL RISK
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would eventually help in reducing the laws that is generated from currency conversion that
needs to be conducted by the company for buying aluminum from the international market
(McNeil, Frey and Embrechts 2015). Buying a long-put option would eventually help in
reducing the loss that increases from strengthening USD against AUD.
ii) Identifying and explaining problems that might be faced by derivative-based hedging
strategies:
The different types of problems that could be identified while implementing the
derivative based hedging strategies identified in the above segment. Moreover, for starting
the hatching process OZPRTS will need to have adequate trading account and other amenities
to hedge its overall exposure. The problems such a accuracy of the trade can be a major
problem for the hedging process, as losses incurred from commodity and currency market
could be hedged. However, the profit that could be generated from reducing commodity
prices and strengthening AUD will also be lost from the hedging process. Therefore, the
accuracy of identifying the accurate hedging price is the major problem faced by companies.
Cost of the hedging could also increase relevant losses for the organization if price remains
stagnant, which could increase expenses of the organization. The combined hedging process
needs adequate strategy which could help in reducing the losses of the organization. using
futures and option contracts would immensely increase the capital requirement of the
company, which will be used as a Collateral for the trade, as mandated by maximum
exchanges (Bessis 2015).
iii) Choosing one the derivative-based hedge instruments for each of the exposure of
OZPRTS Co.:
From the overall evaluation of different ages future contract could be used for
aluminum purchase, while option contract such as long put can be used for hedging

MANAGING FINANCIAL RISK
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AUD/USD. The Futures contract for Aluminum purchase might help the company in
controlling the extra cost, which might increase due to demand and supply of the commodity.
On the other hand, with the use of Option Contract-Long Put for hedging AUD/USD the
company could adequately reduce the losses, which will incur with the strengthening of USD
against AUD. This option contract would eventually help in controlling the excess payment
that could be conducted by the company due to low AUD power against USD
(Markets.businessinsider.com 2018).
c.i) Identifying the currency exposure on revenue side that is faced by OZPRTS Co. on
its sale of engine casings:
The evaluation of case study helps in identifying the exposure of currency on revenue
side that is faced by OZPRTS. The company will mainly sell the aluminum transmission
casings to EU-based automotive manufacturer. Therefore, the exposure of euro currency is
relatively high, which could help in generating high level of returns from investment.
1-Mar
1-May
1-Jul
1-Sep
1-Nov
1-Jan
1-Mar
1-May
1-Jul
1-Sep
1-Nov
1-Jan
1-Mar
1-May
1-Jul
1-Sep
1-Nov
1-Jan
1-Mar
1.25
1.3
1.35
1.4
1.45
1.5
1.55
1.6
1.65
EUR/AUD
Figure 7: Depicting the EUR/AUD price from March 2015 to March 2018

Loss
Profit
Strike price
Long Put
MANAGING FINANCIAL RISK
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(Source: Au.investing.com 2018)
The above figure mainly helps in identifying the overall currency valuation for
EUR/AUD from March 2015 to 2018. This evaluation of the historical currency valuation
could eventually help in depicting the selling price, which will generate high level of returns
for the company. Valuation of Euro currency is relatively increasing in comparison to AUD,
which indicates the profits that could be generated by OZPRTS from selling aluminum
transmission casings to EU-based automotive manufacturer. From the evaluation chances of
increasing AUD value against euro is estimated from the graph represented in figure 7.
Therefore, with the help of adequate hedging instruments any kind of loss that might income
from Currency conversion might be reduced (Titman et al. 2017).
c.ii) Choosing whether to use option or futures hedge against currency exposure that
OZPRTS Co. conducts:
Figure 8: Depicting diagram for Revenue currency hedge Long Put
(Source: As created by the author)