American Barrick, the subject of your next case study, is a Canadian gold mining company. During the 1980s they grew rapidly, in no small part due to their aggressive gold-price hedging program. Towards the end of 1984 Barrick faced a problem. The price of gold had declined precipitously, from nearly $500/oz in early 1983 to around $300 towards the end of 1984. Should the decline continue, the profitability of several of their mining properties would be threatened. To protect against further price declines, Barrick sold a portion of their production forward. This problem asks you to chart the effects of that forward sale on Barrick’s profit per hedged ounce of gold. Suppose that:
• Barrick’s breakeven point is $280/oz;
• Gold is currently selling for $310/oz; and
• The current 1-year forward price for gold is $320/oz.
a. Plot Barrick’s profit per ounce as the price of gold varies between $250/oz. and $350/oz. Put the price of gold on the x-axis and the change in Barrick’s profit on the y-axis. Have the x-axis intersect the y-axis at 0 profits.
b. On the same graph, plot the payoffs on the sale of the forward contract priced at $320/oz.
c. Finally, on the same graph, plot Barrick’s profit per ounce after it sells the gold forward contract.
d. What other simple derivative security could Barrick use to protect its profits against falling gold prices?