Western Mining Company (WMC) is an Australia-based minerals producer with business interests in 19 countries. It is the world’s third largest nickel producer, owns 40 percent of the world’s largest alumina producer (Alcoa World Alumina and Chemicals), and is a major producer of copper, uranium, gold, fertilizer, and talc. WMC builds its business on large, low-cost, and long-life assets that are globally competitive.

Most commodities produced by Australian mining companies, including WMC, are exported and priced in US dollars. Thus, these companies would suffer significantly and their Australian dollar revenue would drop if the Australian dollar appreciated sharply against the US dollar.

Given such an exposure, the conventional wisdom held that borrowing in US dollars would provide a “natural” hedge against their dollar revenue stream. When forward markets began to develop in the mid-1970s, Australian mining companies often hedged up to 100 percent of forecasted revenues with a combination of debt servicing and forward contracts — often for periods up to 10 years. In the early and mid-1980s, the Australian dollar declined sharply against the US dollar, and the “natural” hedge proved not to be a hedge at all, but rather an uncovered short position in the US dollar. As expected, the decline in the Australian dollar increased the cost of serving US dollar debt. And those companies that had also sold forward their expected dollar revenue stream also suffered further foreign-exchange losses as these contracts matured. The positive effect of the stronger US dollar on dollar-denominated revenues was offset by a prolonged slump in mineral commodity prices.
Although WMC also experienced some currency losses, it fared better than many of its competitors for two reasons. First, it had relied more on the equity markets to finance capital expenditures. Second, it had not participated in new major projects in the early 1980s. In 1984, however, the company contemplated investment in a new copper, uranium, and gold mine, with capital costs expected to be about $750 million. Under arrangements with a joint venture partner, the company planned to finance its share of the mine solely with debt, thereby increasing its total debt by a magnitude of two or three times.
When confronted with the need to decide the currency denomination of the debt, WMC concluded that taking a short position in US dollars, whether by borrowing or selling forwards, would not stabilize the volatility of its home-country operating profits. Consequently, WMC decided to borrow in a basket of currencies that included Australian dollars, US dollars, Japanese yen, British pounds, and deutsche marks. The company also decided to discontinue its practice of selling forward US dollar revenues, except when actual sales had been made.
Case Questions 

1 Evaluate the pros and cons of various exchange-hedging instruments and techniques.
2 What are the different types of foreign-exchange risk that WMC will encounter?
3 Explain why borrowings in US dollars and forward sales of US dollar revenues by Australian mining companies in the 1980s had backfired.
4 Explain why WMC decided to borrow in a basket of currencies rather than exclusively in US dollars or Australian dollars.
5 What are two possible ways to hedge economic exposure?
6 Explain why WMC decided not to hedge its economic exposure (i.e., future US-dollar revenues).
7 The websites for various multinational companies disclose exchange rate hedging activities and their exchange gains or losses. (Hint: see footnotes of annual reports.) On the basis of the website of WMC, www.wmc.com.au, or the website of IBM, www.ibm.com, describe the management of foreign-exchange risk for either company.