The Strategy of Petra Diamond for Managing Exchange Risk - Essay Example

Foreign exchange rate risk and political risk management

(Case study on Petra Diamond)

Table of content

1. Introduction4

2. Strategies of exchange risk management of Petra Diamond6

2.1 Foreign exchange rate risk6

2.2 Planning of foreign exchange risk management by Petra Diamond6

2.2.1 Types of Economic exposure faced by Petra Diamond6

2.2.2 Economic exposure mitigation strategy of Petra Diamond7

2.2.3 Types of Transaction exposure faced by Petra Diamond8

2.2.4 Transaction exposure mitigation strategy of Petra Diamond11

3. Political risk management strategies of Petra Diamond12

3.1 Political risk in the country12

3.2 Country and political risk management strategies of Petra Diamond13

4. Suggestions for Petra Diamond to reduce operations, exchange rate risk and political risk15

4.1 Recommendations for operational management15

4.2 Suggestions for exchange rate risk management15

4.3 Strategies for political risk management16

5. Conclusion17

Reference List18

• 1. Introduction

In the recent era of globalisation, the companies face several external and internal risks in running the business successfully (Dhanani, 2004). Strategic risk management is therefore essential for resolving the existing foreign exchange issues as well as political risk to run the company effectively (Ofek and Allayannins, 2001). The main purpose of the assignment is to acknowledge the strategy of Petra Diamond for managing exchange risk and political risk to operate the organisational activities.

Petra Diamond is a leading independent diamond-mining group and the brand is successful in becoming a leading supplier of diamond in the international market (Petra Diamonds Limited, 2016). It is therefore important for the company to manage exchange rate risk as well as political risk for successful development of the company and expanding the business across the globe. The vision of the company is to create excellent diamond group and the mission of Petra Diamond is to develop own assets and increase value of stakeholders. The brand tries to create values for all the business stakeholders by controlling the operational activities and delivering quality and valuable products and services to a wide range of customers across the globe. As the company operates in the international market, Petra Diamond faces several issues and challenges related to foreign exchange rate, cash inflows and outflows including transactional and operational exposure (Petra Diamonds Limited, 2016).

The financial highlights of the company are important in this context to analyse the existing international risk related to fluctuations in foreign exchange as well as international political environment (Chuang, Chen and Lan, 2015). The financial performance of the brand can be illustrated below:

Figure 1: Financial performance of Petra Diamond in 2015

(Source: Petra Diamond Limited, 2015)

Identifying the exchange rate risk and political instability is helpful for the company to withdraw further investment for reducing the upcoming risks (Hull, 2012). The assignment also provides an opportunity to recommend some suitable strategies for reducing the exchange rate risk and political risk through which Petra Diamond can reduce financial risk (Petra Diamonds Limited, 2016).

• 2. Strategies of exchange risk management of Petra Diamond
  • 2.1 Foreign exchange rate risk

Foreign exchange risk or financial risk exists when the transaction of a company is devalued due to currency denomination (Chadrakumaramangalam and Sivarajadhanavel, 2012). The risk is mainly for the adverse movement of the foreign currency exchange rate where the company can be affected for such fluctuations. During the transaction of goods and services, when there is financial risk, the company face financial consequences (Kapila and Hendrickson, 2001). The financial risk includes three types of uncertainty such as transaction, translation and operational risk and it is important to acknowledge for identifying the economic value of the company.

• • 2.2 Planning of foreign exchange risk management by Petra Diamond
    • 2.2.1 Types of Economic exposure faced by Petra Diamond

Apart from the transactional and translation risk, the company Petra Diamond also tries to manage economic or operational exposure for running the business successfully. The operational risk of the company can be described below:

Figure 2: Operational or economic exposure

(Soucre: Petra Diamond Limited, 2013a)

The operational risk of the company includes mining and production sites, expansion and delivery as well as maintaining labour relations (McNeil, 2013). Therefore, the production sites across the globe are helpful for the company to understand the operational or economic exposure of the brand. In order to reduce the operational risk, Petra Diamond can diversify the production units of the brand to identify the operational exposure (Petra Diamonds Limited, 2014).

• • • 2.2.2 Economic exposure mitigation strategy of Petra Diamond

In order to reduce the operational risk, the company tries to ensure the safety of the Petra people in the workplace as well as at mining. Petra is highly concerned about the safety and healthy situation, which is provided to the employees for reducing hazardous condition, instilling safety and awareness, risk assessment and maintaining workplace culture. Moreover, the mining of diamond includes several risk factors due to geopolitical environment, technical failures, weather condition and hazardous workplace (Petra Diamonds Limited, 2016).

In this regard, Petra tries to focus on the strategies such as maintaining economies of scale, developing new diamond mine and Brownfield expansion for reducing the operational exposure. Petra’s diversified portfolio of diamond mine is an effective strategy for improving overall portfolio performance and secure long-term growth through more expansion. Therefore, managing labour relations, expansion, safety at workplace, mining and production by maintaining economies of scale are the effective strategies of Petra for reducing operational exposure (Petra Diamonds Limited, 2014). The company tries to dominate the transaction in foreign currency, which is changing as per the economic situation of the country to reduce economic exposure. The company can reduce the impacts of foreign currency risk on the operational exposure through managing cash flows, acquiring more inventories and holding foreign currency (Petra Diamond Limited, 2013b).

• • • 2.2.3 Types of Transaction exposure faced by Petra Diamond

Transaction exposure is important under foreign exchange risk in which the values of the brand depend on the unanticipated fluctuations of exchange rate (Bromiley et al., 2015). In order to understand the value of domestic currency, it is important to transfer the domestic currency at foreign exchange rate and therefore, fluctuation of exchange rate determines the appreciation or depreciation of domestic currency (Baxter et al., 2013). The exchange rate risk refers to the negative impacts on the domestic currency due to adverse movement of foreign exchange rate. The transaction exposure is risky for the brand, which results lower profitability, decreased market value and revenue offshore and poor cash flows. As per the annual report of Petra Diamond, there is transaction exposure, which affects diamond price, currency values and market values of diamond (Interactive investor, 2015).

Figure 3: Exchange rate risk

(Source: Petra Diamond Limited, 2015)

Figure 4: Decreased revenue and net income due to currency fluctuation

(Source: Financial Times, 2016)

Petra Diamond faces several foreign exchange issues as the diamond industry is highly risky and unrealised gains and losses cannot be predictable due to exchange rate fluctuation. As per the figure, the profitability and net income also decreased in 2015 as compared to 2014 (Financial Times, 2016). In 2011 and 2012 as well as 2015, due to fluctuations in foreign currency rate, the brand lost approximately 0.48 USD per share, which will further affect the cash flows and market value of Petra’s share (Morningstar, 2016).

Figure 5: Earning per share

(Source: Financial Times, 2016)

• • • 2.2.4 Transaction exposure mitigation strategy of Petra Diamond

Petra has significant Capex program though which the brand can predict the operational cash flows and debt ratio for further development of the company. The company tries to monitor continuously for understanding the financial planning after analysing the movement of cash flows and debt ratio. Due to the fluctuations, there is also the risk of diamond price, which further affect diamond production level and customer’s demand. The production and operational units of the brand are mainly situated in South Africa, but transaction of diamond is conducted in US dollar, which is risky for the brand due to such foreign exchange rate fluctuations (Financial Times, 2016). The group in this regard tries to transact the products across the globe to diversify the risk factors. The company tries to hedge a portion of future diamond sales to reduce the risk factors (The telegraph, 2012).

Volatility in ZAR/US$ results more management of financial cash flows for addressing the foreign exchange risk. As per the annual report of Petra, there was significant loss in 2001 and 2012 due to adverse movement of exchange rate, which further increases the transaction exposure of the brand. After proper identification of the foreign exchange risk, hedging is the most important strategy that can help the brand to reduce the expected risk. However, the hedging strategy hampers cash flows of Petra and profitability as well as the cost of hedging may decrease the interest of the shareholder. Though there are several consequences of hedging, money market hedging techniques can help the brand to fix the rate of transaction contributing reduction in transaction exposure.

• 3. Political risk management strategies of Petra Diamond
  • 3.1 Political risk in the country

Country or political risk is another factor that has crucial impact on the cash flows and investment of the business, which further create more risky business environment to run the operational activities successfully (Huber and Scheytt, 2013). Instability in political situation of South Africa legislative bodies, foreign policy in the international market and transformation of government are the main factor that creates political or country risk for which Petra Diamond faces several risk in operating the business across the globe.

The government of the country controls tax rate, subsidies and interest rate of money, which have crucial impact on the financial performance. In this regard, the company needs to manage the political risk by managing the risk factors. Continuous monitoring process of macro business environment is important for developing effective mitigation planning for the political or country risk. The instability in the country or political risk results in potential financial and operational loss and the factors are mainly rules, legislations, regulations in conducting the business activities and government’s decision (Petra Diamond Limited, 2013b).

Figure 6: Country or political risk

(Source: Petra Diamond Limited, 2015)

• • 3.2 Country and political risk management strategies of Petra Diamond

The operations of Petra are mainly based on South Africa with lesser exposure to Tanzania and Botswana (Petra Diamonds Limited, 2016). The emerging market is more risky due to several economic factors, rules, regulatory framework, tax and subsidy structure and political risk. Due to these risk factors, the brand faces high country or political risk. In order to reduce the risk, the company tries to monitor regulatory and political framework of Africa as the brand mainly develop the production units in South Africa. Petra tries to improve engagement with the government and regulatory body of Africa to run the business smoothly without any ethical issues. The company faced the controversies related to labour disruption in 2012 and 2013, which further increased the risk factor in operating the business in Africa (Petra Diamond Limited, 2015).

The brand faced social challenges due to the risk Labour unrest in South Africa, which affect the smooth operations of the brand. In this regard, the company tries to improve involvement with the employees and encourage open communication with the employees, trade unions and local communicative representatives for building strong relationship with the employees. Through providing safety and healthy work environment and maintaining the labour regulations, the brand tried hard to mitigate the political risk and cooperate with employees to resume the operations in a timely manner. Petra’s employment policies and incentive structure are effective for the brand to retain loyal employees towards the brand for securing sustainable development in near future (Petra Diamond Limited, 2015).

On the other hand, Petra is also concerned in managing high regulatory framework and maintaining license for developing smooth operation and mining. Maintaining accountability and business transparency are other strategies through which the brand tries to encourage the employees and retain more long-term expertise towards the brand. Employee’s empowerment is another strategy through which Petra tries to empower the staff for sharing ideas and thoughts contributing more cooperative work environment. Without proper maintenance of legislations in South Africa, Botswana and Tanzania, the brand cannot manage the mining and exploration and therefore, Petra tries to manage all the legislations successfully for reducing political risk (Petra Diamond Limited, 2015).

• 4. Suggestions for Petra Diamond to reduce operations, exchange rate risk and political risk
  • 4.1 Recommendations for operational management

As the profitability and net income decreased in the last year as compared to 2014, it is important to implement effective strategies through which the brand can develop the business and expand it successfully across the globe.

• In this regard, Petra needs to develop efficiency of the production and manufacturing techniques so that it is possible to reduce the operational cost of the product. The brand can reduce operational risk and increase profitability and sales volume through effective strategy.
• Production diversification can be another important strategy through which Petra can perform better and speculate the operational risk in different production sites.
  • 4.2 Suggestions for exchange rate risk management

Forward and call option are the main strategies of reducing the exchange rate risk through which Petra can resolve the issues and secure sustainable development in near future. Through this strategy, the brand can hedge the assets or speculate the future options which is crucial for mitigating the existing risk due to exchange rate fluctuations,

• Forward:

Petra can incorporate the forward contract for selling and buying the contract to other party. As per the forward contract, the buy or sell can be established at a future specified time or date at an agreed price during the contract. This is a derivative instrument for reducing the risk of exchange rate fluctuation. However, there will be depreciation or appreciation of money in future, the buyer can get the same price that was fixed at the date of the contract. Therefore, the brand can implement the strategy of forward contract for hedging the assets and secure predetermined cash flow of the company.

• Options:

The option contract can give the authority to the holder to transact the domestic currency against foreign currency at a particular time at a future specified rate and quantity. It is the strategy through which the contract can be matured at future specified price and rate. The buyer of the contract has the right to assume particular future position of the asset and set specified price and quantity before the option expires (Smith and Stulz, 2012). Therefore, the brand can reduce the negative risk of transaction of assets through this effective contract.

• • 4.3 Strategies for political risk management
• Diversification is an effective strategy through which the brand can reduce the county or political risk as it increases the presence of Petra in different geopolitical region. Through this policy, the cost of potential risk can be reduced and in this regard, Petra tries to diversify the locations of production and mining to spread the risk across different plant.
• Managing all the regulations and transactions system of the country is another strategy of mitigating the country or political risk. Petra can reduce the risk by managing labour laws, export or import legislations, investment planning and managing the rules of mining without hampering the natural resources.
• 5. Conclusion

The brand Petra Diamond faced several risk due to fluctuation on foreign exchange currency for which the domestic currency can be devalued or appreciated according to the movement of foreign currency. In order to reduce the existing risk in the market, the brand tries to develop effective strategies for expanding the business successful across the world and running the operational activities efficiently. The company faced transaction exposure, economic or operational risk as well as country or political risk for which the profitability volume of the brand is affected. The company needs to implement the strategy of production diversification and reduction of operational cost by managing economies of scale of production to reduce operational exposure moreover. Through developing forward and option future contract, Petra can reduce the translations risk and secure high financial performance. Moreover, in order to reduce political risk, the brand needs to maintain all the government’s legislations, which is also effective for running the business sustainably.

• Reference List

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Chadrakumaramangalam, S. and Sivarajadhanavel, P., 2012. Exchange Rate Risk in the Foreign Exchange Market: A Challenge on Corporate Profitability. Bonfring International Journal of Industrial Engineering and Management Science, 2(3), pp. 8-11.

Chuang, S., Chen, C. and Lan, L., 2015. Exchange rate risk management: What can we learn from financial crises? Economic Modeling, 45, pp. 187-192

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Huber, C. and Scheytt, T., 2013. The dispositive of risk management: Reconstructing risk management after the financial crisis. Management Accounting Research, 24(2), pp.88-99.

Hull, J., 2012. Risk Management and Financial Institutions. London: John Wiley & Sons.

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McNeil, A.J., 2013. Enterprise Risk Management. Annals of Actuarial Science, 7(01), pp.1-2.

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