Financial Risk Management

Professor David Veredas

Term-III

Group Assignment 3

Company Allotted: Anglo American

Group 1

Akhilesh Kejriwal
Aryan Setu
C S Guru Karthick
Kshitij Vats
Ridhi Musaddi
Q. Why does the company manage currency, commodities, and interest rate risks?
Ans. The group classifies financial risk exposures into the following types: 1. Liquidity risk 2.
Credit risk 3. Commodity price risk 4. Foreign exchange risk 5. Interest rate risk. We did
detailed research on the last 3 types as per the question’s requirement. However, we found
that the company does not specifically answer the question, “why does it manage these
risks”. So, we’ve tried to base our answer on some statements we found spread across the
report, fully/partially referencing the relevant risks and based on our understanding of the
company’s business model.
Commodity risk is present for the organisation as a minor one in regard to the prices of the
commodities it produces. As a result, the organisation doesn’t put too much focus on
hedging this risk. The most frequently used instrument is the forward contract, as it serves
the purpose of hedging for them, which is protecting themselves from the price fluctuations
of the commodities sold as provisionally priced. Currency risk, on the other hand, impacts
the group on a much larger scale as a result of global operations (non-USD costs &
revenues). Strengthening of the US dollar against the non-US dollar currencies influencing
costs the group is exposed to had a positive effect on the group’s earnings (proving risk can
be positive as well). The group’s policy is generally not to hedge such exposures, given the
correlation, over the longer term, with commodity prices and the diversified nature of the
group. Also, the management decides to hedge against the currency risk on a case-to-case
basis regarding projects & borrowings. Managing interest rate risks is also important for the
group since they have borrowed significant money in various countries. This makes the
company exposed to changes in interest rates in the countries it has borrowed. This can
make it extremely hard for them to predict future cash flows, without which precise future
planning gets impossible to do.
The management feels that, as per their currency & interest rate risks exposures and with
the hedging arrangements in place, their earnings and equity are not materially sensitive to
reasonable rate movements in respect of the financial instruments held currently (page 254,
last para).

Q. How does the company manage these risks?

Ans. The company uses forward contracts and other derivative instruments to hedge the
price risk economically. In many of the company’s sales and purchases, the selling price is
normally determined 30 to 180 days after the delivery is done to the customer. This selling
price is based on quoted market price specified in the contract, which makes it susceptible
to future price movements. Thus, hedging, in such cases, protects the company from
negative exposures to price movements. Table 1 (references) shows the exposure of the
company’s financial assets and liabilities to commodity price risk.
Next is currency risk. The major non-US currencies affecting the costs of the company are
the Australian dollar, Chilean peso, Brazilian real, and South African rand. The company's
policy is normally not to hedge such exposures. However, certain exceptions are allowed by
a committee with delegated authority from the Group Management Committee. Also, the
company is exposed to currency risks to a certain extent in terms of non-US dollar capital
expenditure and dollar borrowings in US dollar functional currency entities. In such cases, an
analysis is done on whether to hedge or not depending upon certain factors like the liquidity
of foreign exchange markets, the cost of executing a hedging strategy and estimated foreign
exchange exposure. The most frequent instrument used to hedge currency risks is currency
swaps.
Interest rate risk occurs because of interest rate fluctuations which affect the company’s
financing activities. Anglo American is majorly exposed to US and South African interest
rates. By June 2023, an alternative risk-free rate is expected to replace USD LIBOR. So,
regarding its hedging agreements and upcoming financial market operations, the company is
currently managing the switch to alternative risk-free rates. The company’s policy involves
borrowing funds at a fixed rate of interest. The company uses interest rate derivatives to
convert most of its borrowings to floating rates of interest and manage the exposure to
interest rate movements. The company’s policy with financial assets is to maintain liquidity.
They are trying to achieve this by investing cash at floating interest rates and maintaining
cash reserves in short-term investments of less than a year’s maturity. Table 2 shows the
company’s exposure of net debt to currency and interest rate risk.

Q. How does it compare with competing companies?

Ans. Rio Tinto has a broad commodity base, so it is exposed to changes in commodity
prices. Generally, their policy is to sell their products at prevailing market prices like Anglo
American. As per Rio Tinto policies, they don’t normally consider that usage of derivatives to
fix prices would provide long-term value to their shareholders. But for certain commodities,
derivatives contracts are used. They use embedded derivatives for that (annual report page
196). Regarding currency risk, under normal market conditions, the company doesn’t
consider actively hedging currency as they believe it will not provide any long-term benefits
to their shareholders. There is a committee which reviews the company’s exposure on a
regular basis, and currency protection measures are undertaken only under specific
commercial circumstances. Rio Tinto’s interest rate risk management policy involves
borrowing and investing at floating interest rates. The company uses interest rate swaps to
convert bonds with fixed rates to floating rates. The company is exposed to long-term fixed-
rate funding because at times maturity of interest rate swaps is shorter than that of bonds.
So, to maintain floating rate exposure, new medium-dated swaps are transacted as interest
rate swaps mature. At times, the company chooses to maintain fixed rates, but that is
circumstantial.
Glencore categorises risks into three broad heads: market, credit, and liquidity. Our focus
risks fall under the category of market risk. Unlike Anglo American, this company takes all
risks seriously and hedges actively against them. For commodity price risks, they manage the
exposure through futures and options transactions on worldwide commodity exchanges or
in OTC markets to the extent available. Their hedging methods for interest rate risks include
the matching of assets & liabilities, swaps, and similar derivative instruments. Coming to the
currency risk, the US Dollar is the predominant functional currency of the group. Their
preferred hedging tools are the forward exchange contract and swaps.
 REFERENCES

 Investors | Anglo American

 aa-annual-report-full-2022.pdf (angloamerican.com)
 https://www.angloamerican.com/investors/annual-reporting#
 Anglo American Plc Peers & Key Competitors - GlobalData
 Glencore Digital Annual Report 2021
 Risk Management & Financial Reporting (riotinto.com)
 https://www.riotinto.com/en/invest/reports/annual-report
 https://cdn-rio.dataweavers.io/-/media/content/documents/invest/reports/annual-
reports/2022/rt-annual-report-2022.pdf?rev=7a10cc8ddcf14ecf9bc5133070c33e85

Table 1.

Table 2.