Directors or the Management of Businesses †Myassignmenthelp.Com

Question: How to the Directors or the Management of Businesses? Answer: Introduction At the time of running of the businesses, the board of directors or the management of the businesses has to face some major financial risks. These financial risks are major hindrances for the performance of the businesses. Examples of the major financial risks are exposure risk, operational risk, credit risk, market risk, foreign exchange risk, economic volatility risk, liquidity risk, inflation risk and many others (Hull 2012). In order to mitigate all these financial risk factors, the business organizations need to employ effective risk management strategies. Financial Risk Management is the process of increasing the economic value of the organization by effectively managing the above-mentioned risks effectively. In the process of financial risk management, the business organizations use different kinds of strategies as if the strategy is diversifications and others (Christoffersen 2012). In the process of risk management, a crucial strategy is the hedging strategy. Hedging is the process to reduce or to control the financial risks of the business organizations. The main objective of the process of hedging is to reduce the risks related with the future change in the value of future position. Different kinds of techniques are used in the process of hedging; but in this process, hedging takes opposite and equal position in two different markets. Another crucial objective of hedging is to protect the capital of the business against the economic inflation with the help of investment in the financial instruments with high yield. Hence, hedging can be considered as one of the major tools to reduce different kinds of financial risks of the businesses (Bielecki and Rutkowski 2013). Company Background The study involves with the analysis and evaluation of the financial risk management processes of one of the best mining companies. BHP Billiton Limited. BHP Billiton is one of the largest Anglo-Australian multinational mining corporations that are involved with the processes of mining, metals and petroleum. The company was incorporated in the year of 1985 and the headquarter of the company is in Melbourne, Australia. BHP Billiton has its business operations spread all over the world. The major products of the company are iron ore, coal, natural gas, copper, petroleum and others. BHP Billiton has an employee base of 65,000. It has been seen that the company has been facing some major financial risks like external risks, operational risks and others (bhpbilliton.com 2017). Identification of the Primary Financial Risks of BHP Billiton In the business operations of BHP Billiton, the management of financial risks is an important aspect. One of the major mottos of the company is to provide greater certainty and confidence to the stakeholders of the organization by managing the business risks effectively. On the other hand, the process of business decision-making of BHP Billiton largely depends on the financial risk management of the company. As the study is about the financial risk management of BHP Billiton, it is needed to discuss the major financial risks of the company. The primary financial risks of BHP Billiton are shown below: One of the major financial risks of BHP Billiton is involved with the failure of Samarco dam. On 5 November 2015, the Samarco dam faced a trailing failure. This dam failure had an adverse effect on the financial operations of the company (Labonne 2016). The Samarco dam failure significantly affected the financial result of BHP Billiton in the financial year 2016. After the failure of Samarco dam, the business operations of BHP Billiton were closed for some days. This is an example of the incidents from where financial risks are derived. Apart from this, there are some other risks in the business operations of BHP Billiton. Another crucial financial risk of BHP Billiton is the interest rate risk. As per the financial report of BHP Billiton, the company had a total debt of $43,342 million in the year 2016. The amount of interest that needs to be paid is $12,241 million. Thus, it can be seen that the company has a huge amount of debt and this loan amount leads to a huge amount of intere st that needs to be paid in the future period (bhpbilliton.com 2017). It can be seen that BHP Billiton is exposed to the interest rate risks due to the huge amount of long-term debts. The floating rate of interest is changed with the economic condition of the country (Wu 2013). The next significant risk is the currency risk. It can be seen that the rate of currency is related with the economic condition of the country and the rate of interest. Due to worldwide economic slowdown, a significant fluctuation can be seen in the exchange rate of the currencies (Su et al. 2013). The next primary financial risk is the commodity price risk. Due to the world economic slowdown, the purchasing power of the customers has decreased and this reason affects the price of commodity of BHP Billiton. Another major financial risk of BHP Billiton is reduction in the Chinese demand. As per the speculation of the board of management of BHP Billiton, this reduction of demand is going to negatively affect the financial results of the organization (Lf and Ericsson 2015). Years Particulars Details 2012 2013 2014 2015 2016 Earnings Per Share (EPS) A 5.79 4.09 5.2 0.71 -2.4 Market Price Per Share B 78.42 68.2 47.32 25.76 35.78 Dividend Per Share C 2.2 2.28 2.36 2.48 1.56 P/E Ratio B/A 13.544 16.6748 9.1 36.2817 -14.908 Dividend Yield C/B 0.02805 0.03343 0.04987 0.09627 0.0436 The above table shows the Profit Earning Ration (P/E Ratio) and Dividend yield ratio for the last five years starting from 2012 to 2016. A higher amount of P/E ratio indicates that the investors are speculating higher growth of the company. From the above, it can be seen that the P/E ratio is in negative in 2016 as compared to 2015. Even the P/E ratio is in negative in 2016. It indicates that the investors are highly disappointed with the company due to various financial risks. From the dividend yield, it can be seen that the company has given less amount of dividend in 2016 as compared to 2015. It implies that the profit of the company is danger as the company is providing less amount of dividend. Recommendation on Hedging The above discussion sheds lights on the financial risks of BHP Billiton Limited. It can be seen that BHP Billiton has adopted many attractive strategies to mitigate the financial risks of the organization. However, based on the discussion about the primary financial risks of the organization, some major recommendations are provided below: In case of Samarco dam failure, it is recommended that BHP Billiton needs to investigate more on this failure to know the actual reason of the failure. In order to employ the effective risk management strategy, it is needed to know the main reasons of the failure of the dam. In this regard, it is necessary to form an investigation committee to discover the major reason of the failure (Smith 2016). As per the above discussion, another major primary financial risk of the company is the interest rate risk. As the fluctuation of interest risk is largely depends on the economic condition, the process hedging is to be recommended in this regard. The strategy of hedging is needed to mitigate the risk involved in the interest rates (Bingham and Kiesel 2013). As per the above discussion, the nest risk is the currency rate risk. In this regard, the recommendation is to adopt the strategy of hedging in the aspect of currency risk. As per the annual report of the organization, the company has also adopted the strategy of hedging in case of currency risks. The recommendation is same as the adopted strategy of the company as the process of hedging helps to reduce the financial risks of the organizations (Scordis and Steinorth 2012). The above discussion indicates that the next risk of BHP Billiton is the commodity risk. In relation with the commodity price risk, it is recommended to employ the strategy of hedging. The strategy of hedging will be helpful to mitigate the risks related to the commodity prices. The recommendation is provided in accordance to the strategy of the company as the company also adopted the strategy of hedging (Goss 2013). In case of the reduction of Chinese demand, it is recommended to investigate into the matter to know the reasons of the decrease in the demand. These are the recommended strategies that BHP Billiton needs to strategies to mitigate the financial risks of the company (Shen, Gao and Cheng 2012). Recommendation on Hedging As per the above discussion about the recommendation regarding the solution of the financial risks of the organization, there are three cases where the strategy of hedging is recommended. They are interest rate risk, currency rate risk and commodity price risk. this part of the study shows the type of derivatives strategies that needs to be strategies. In the case of interest rate risk, it is recommended to adopt the swap derivative for the process of hedging. Swap derivative is considered as one of the most complex derivatives. The adoption of swat derivatives allows the participants to change their cash flows. It can be seen that BHP Billiton has a large number of term debts and for this reason, the company has to pay a large amount of interest in the future. However, with the help of hedging through swap derivative, the company will be able to change its rate of interest from fixed rate to floating rate or floating rate to fixed rate. This is a private contract and the related parties can go for negotiation at the time of hedging (Saretto and Tookes 2013). In case of the currency risk, it is recommended to adopt the strategy of forward contract derivative at the time of hedging process. Forward contract is the most common and widely used contract. In the process of forward contract, two parties are agreed upon a contract to sell something in the near future and the selling price is determined at present situation. With the help of this hedging strategy, BHP Billiton will be able to set the price of the currency based on the recent time. This will help the organization to avoid the negative effect of the change in exchange rate of the currencies. It is not compulsory to disclose the all the information about forward contract hedging to people (Aid, Campi and Langren 2013). However, in case of the currency risks of the organization, the most suitable procedure will be the hedging process with the help of future contracts. In case of the future contracts, the selling or buying process takes place in near future, but the prices in which th e selling or buying process takes place will be determined in the present time. The third risk is about the risk of commodity price. In this regard, it is recommended to adopt the option contract in the process of hedging. In the process of option contract, to parties are agreed upon to sale or purchase something in the near future. In this case, one party has the obligation to sell or purchase in the near future and another party has the power to decide whether he/she wants to sell or purchase. With the help of this strategy, BHP Billiton will be able to sell his products in the near future. In this derivative, the organization will be able to make decision on the selling or purchasing the commodities in pre-determined prices. This process of hedging will be useful for the company to mitigate the risks regrinding the prices of the commodity of the organization (Voit 2013). Hedging Strategies As per the above discussion, it can be seen that there are three kinds of risks. They are interest rate risk, currency rate risk and commodity price risk. Among all these three risks, the currency rate risk and commodity prices risk will be hedged with full exposure. The interest rate swap will not be hedged. Same like the interest rate risk, the currency rate risk will not be hedged. The main reason is that the company has its presence all over the world and for this reason the company has to make currency exchanges in several countries. The main focus of the report is to make the hedging of the commodity price risk of the company (Dong, Kouvelis and Su 2014). Hundred percent of the exposure of commodity price of the company will be hedged. It implies that company will hedge all the future purchase of the commodities of the organization as the company is considering that there will be fluctuations in the future price of the commodities. As per the provided information, the hedging time or horizon is December 2017. As the company is dealing with crude oil, the future prices of crude oil will be USD $51.74. However, the company is speculating that the price of crude oil will be decreased in the near future. Hence, there is a risk that the company may have to face losses. For this reason, the company will buy put option. This process will help the company to hedge the loss amount. For example, the company is considering the fact the price of crude oil will be decreased to USD $45.74 in future. If not hedged, the company has to face the loss of USD $6 ($51.74 - $45.74). The advantage of having the hedging strategy is that with the help of put option, the company will hedge the risk of USD $6 (Loss 2012). Particulars Value Hedging Strategy Buy Put Current Price USD $51.74 Expected Price (Future) USD $45.74 Declining Price USD $6 ($51.74 - $45.74) Adequacy of Hedging in BHP Billiton As per the above discussion, it can be understood that the main purpose of the implementation of the hedging process is to minimize the risks of the business organization. There is not any exception of this fact in case of BHP Billiton. From the annual report of the company, it can be seen that the company has adopted the strategy of hedging the various aspects of the financial business operations. It can also be been seen that the company has adopted different derivatives for different business operations. One can take the example of currency rate risk of the company. It can be seen that the organization have adopted the swap derivative for the process of heeding. In case of the commodity price risk, BHP Billiton has adopted the future contract hedging strategy. Hence, it can be seen that the company has hedged the business operations based on the merit of the risks. In this regard, it can be said that BHP Billiton has done quite a good job as the company is adequately hedged. Howev er, it is recommended the company needs to frequently review its hedging techniques to know that whether there is any loopholes in the hedging process of the company. It is also recommended that BHP Billiton should also search for scopes so that the hedging processes of the company can make more effective (bhpbilliton.com 2017). Conclusion According to the above discussion, it can be seen that there are some major financial risks in the business operation of BHP Billiton. They are commodity price risk, interest rate risk, currency rate risk, decrease in Chinese demand, the samarco dam risk and many others. Among all these risks, commodity price risk, interest rate risk and currency rate risk demand the strategy of hedging to be minimized. As per the recommendation, swap derivative hedging process will be applicable for interest rate risk; forward contract derivative risk will be applicable for currency rate risk and option contract derivative hedging process will be applicable for commodity price risk. It can be seen that BHP Billiton is adequately hedged as the company has hedged most of the business activities based on the merit of the risks. However, it is recommended that the company need to review its hedging activities for improvements. References Aid, R., Campi, L. and Langren, N., 2013. A Structural Risk?Neutral Model for Pricing and Hedging Power Derivatives.Mathematical Finance,23(3), pp.387-438. BHP Billiton. (2017).BHP Billiton | Minerals Australia. [online] Available at: https://www.bhpbilliton.com/our-businesses/minerals-australia [Accessed 19 May 2017]. Bhpbilliton.com. 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