Hedging against exporting costs and risks in the South African extractive industry

Abstract

The revolutionisation of international economies and monetary systems has been taking place since the early 1970s. This occurred due to the diminishing fixed exchange rate systems of, initially, the Gold Standard and subsequently the Bretton Woods System. The collapse of these systems, especially the Bretton Woods System, led to the almost free movement of exchange rates. The lack of restriction placed on the movement of currencies created volatile markets; which, in turn, gave rise to an innumerable amount of risks. In Correia, Holman and Jahreskog (2012) it was determined that an astonishing 74% of non-financial firms in South Africa hedge foreign exchange risk (the risk of currency movement). The 10% of firms which did not hedge any risks declared it was due to the lack of exposure to foreign exchange risks and that the cost of acquiring a hedging contract, in many cases, exceeded the contract's benefits. In the aforementioned study it was also established that the extractive sector of South Africa is one of the industries referring from the use of hedges. The intention of this study is to improve the effectiveness of derivative instruments for companies in the extractive sector of South Africa exporting to the United States of America. South Africa is a large exporter and importer of goods, making it extremely important for market participants to determine the movement of the exchange rates. This estimates the amount of risk a company is willing to take and the amount of hedges they will use to protect themselves against inauspicious and adverse movements in the markets. Therefore, incorporated in this study is the use of risk management tools from the technical analysis to predict the exchange rates at which companies should have set their hedging contracts on specific dates. This analysis could enable companies to perform an internal control that is inexpensive and which reduces risks of foreign exporting.