Assignment Corporate Finance
Element 1: Individual presentation of finance and risk reduction strategy for an organization
The purpose of the presentation report is to identify and elucidate the finance and risk reduction strategy of an organization for an ongoing construction project. The chosen organization is China General Nuclear (CGN) which is a based in Guangdong, China. It is a multinational large energy corporation group involved in construction and infrastructure investments.
The risk management involves identification of the different types of risk posed to the chosen organization by the construction project, Hinckley Point C nuclear power station by EDF Energy which is under development so that the company can carry out appropriate risk reduction strategies. General Nuclear (CGN) is a proposed investor in the nuclear power station construction project.
As a result of globalization, there are several opportunities for the investor organization, China General Nuclear (CGN) in the construction sector projects in the United Kingdom.
The investor has attractive business opportunity to earn high return on investment and increase the profit margins from this multi-billion project. Another opportunity is involve in financing and construction to own considerable share in this promising construction project.
The investor has opportunity in making the construction industry better by supporting the Hinckley Point C nuclear power station construction project and new construction tools and technology considering the large impact it will have on completion for a productive era.
Some of the specific opportunities include
-Construction of nuclear power station and experience gained
-Investment in new energy centre
-Improvement of the construction infrastructure
-Establishment of training centers or workshops for the power station
-Use of new construction technologies and tools towards modernizing construction in the UK
-Improved communication, collaboration and cooperation due to digitalization in construction of large projects in the UK among the company, contactors, sponsor and international investors
-Real time information access and data driven decision-making
There are different risks to the investor organization by this construction project. There are different type of investment risk associated with any project as all the investment has element of risk, has tax associated and there is uncertainty about the expected rate of return (Bielecki and Rutkowski, 2013). Similarly, the potential investor organization, China General Nuclear would have an investment risk as there is no ideal investment.
In addition, the investment risk can be due to various factors like political uncertainty in the UK, currency/ exchange rate fluctuations, change in the rate of interest, and change in the economic trend, and change in market trend and due to inflation. For this project, the investment risk can also come for the failure of the construction project.
In relation to the investment risk, the inflation risk, interest rate risk and market risk is also common for the construction project. Inflation risk can be related to the cash equivalent assets while market risk which affects the stocks due to change in market trends.
Market risk is apparent in this nuclear power station construction project as the investment decision is based on the market assumption, technical analysis and potential of the project in future which leads to conclude about the investment performance and possibility of obtaining profits for the investor organization (Jenkins et al., 2017).
However, any change in the UK market leads to change in assumption and change the ratio of risk or losses vs. rewards from the investment made. The high interest rate risk might affect the prices of the bond making its value lower (Chernenko and Faulkender, 2011). Thus, investors who provide investments by buying the company stocks are more likely to pose interest rate risk.
It can be said that there can be a decline in value of fixed rate debt instrument arising from this risk (Srivastava and Srivastava, 2010). Investors in buying bonds, securities or preferred stocks under a fixed return rate can be affected as due to rise in interest rate there will an increased risk of interest rate for their investment.
Another is foreign exchange risk which China General Nuclear as investor is likely to face as high and frequent fluctuations in the exchange rates affects the foreign currency denominated investments (Menkhoff et al., 2012). It can be said that due to currency risk for the change in foreign currency against home currency would pose risk to the security value.
Here, the investor organization deals in Chinese Yuan and Pound Sterling for receivables and payables at current exchange rates. Thus, any unfavorable change in exchange rates risk is present during making payment or before receiving payment.
In addition to this, there are several other risks that can have potential impact on the financial/ investment outcome for the China General Nuclear. The investor is exposed to the performance risks where there are chances that the nuclear power station project might be unable to deliver the intended outcomes like earnings per share and expectation of high revenue.
One such outcome for investor is failure to receive an expected return and loss of principle (Domnikov et al., 2014). Under the performance risks, the operational risk is most obvious in this nuclear station construction project as the project owners can face unexpected changed due to insufficient operational capacity and labor shortage , strikes, accidents, poor site conditions and other hiring or staffing or execution issues.
The natural risks can also affect the project like floods and earthquakes which can make the access for construction sites work difficult or impossible which can result in cost overrun and time delay in completion of Hinckley Point C nuclear power station project. This also impacts the rate of investment returns for the investing party.
In order to mitigate the investment risk, the strategy is to diversify. The investments can be diversified under stocks, cash equivalents, money market funds, bonds, etc.
Thus, the investor can diversify the investments for this construction under different assets classes as a risk reduction strategy. The use of derivatives can be appropriate towards the risk management to deal with the investment risk. The financial derivatives like hedging can be used as risk reduction strategies as they draw value from underlying assets to lessen the risk of foreign exchange for the investor party.
The derivatives can hedge a position to protect against the risk of price movement or risk of asset unfavorable move (Chernenko and Faulkender, 2011). Hedging can help the investor to take an offsetting position in linked security to mitigate the risk of price movements in security through a contractual agreement (Campello et al., 2011).
Thus, hedging can be useful for investor organization to secure its position from the risk of price fluctuations the project company may have and also to deal with the risk of project in meeting the revenue expectations and the earnings per share.
The use of forward contracts can be used as hedge instrument. This kind of hedge will lock the current exchange rate value at which the currency transactions (payable/ receivable) will take place at some later time in the future.
Also another kind of hedge can be used which is options which will set the value of exchange rate that the company can provide option to transact with foreign currency in situation of unfavorable current exchange rate.
However, the forward contract hedge is most suitable kind of hedge that can be used by the Chinese investor organization which serve as a binding agreement as in ‘options’ company will not exercise options hedge if current exchange rate is more favorable towards it thus, there is no obligation for the company as they are non-binding agreements (Campello et al., 2011).
In addition, the investor can make use of another type of derivative which is put option contract that will allow the investor to right to sell the shares to lock the desired profits per share of the investments made to the project.
The risk reduction strategy for foreign exchange rate/ currency risk can be mitigated by the use of another financial derivative, FOREX hedge also known as foreign exchange hedge. This financial derivative can be used by the investor organization to hedge the risk of change in foreign exchange rate for transacting in foreign currency with the UK government.
Under this derivative, the risk from the investor organization can be transferred to another business (such as bank) that carries the foreign exchange risk (Denga and Jain, 2017). Under this derivative, hedging can be either cash flow hedge or fair value hedge where the exchange rate loss is adjusted to other comprehensive income or to the assets respectively.
Thus, the investor organization can take this investing opportunity through a proper risk management plan that allow for identifying potential risks, measurement of risk and selection of most appropriate risk reduction strategies.
Also, by use of hedging technique investor together with the company can reduce the risk arising due to change in foreign exchange rates. In addition, for investment decision making the investor can make use of Net Present Value (NPV) to analyze the profitability value of an expected investment by difference among the cash inflows and outflows the present value over a time period.
It can be concluded that the Hinckley Point C nuclear power station construction project present both risk and opportunities for the potential investor, China General Nuclear.
However, the weightage of opportunities are more for the investors than the potential risk which can be mitigated, transferred and lessen by the use of appropriate financial derivatives.
The use of risk reduction strategies provide insight on how identified risk can be managed and guide the strategic decision for making the financial investment for undertaking this construction project.
Bielecki, T.R. and Rutkowski, M., 2013. Credit risk: modeling, valuation and hedging. Berlin: Springer Science & Business Media.
Campello, M., Lin, C., Ma, Y. and Zou, H., 2011. The real and financial implications of corporate hedging. The journal of finance, 66(5), pp.1615-1647.
Chernenko, S. and Faulkender, M., 2011. The two sides of derivatives usage: Hedging and speculating with interest rate swaps. Journal of Financial and Quantitative Analysis, 46(6), pp.1727-1754.
Denga, S. and Jain, A., 2017. Forex risk management for multinationals: internal and external hedging techniques. In София (Vol. 280, pp. 51-61).
Domnikov, A., Chebotareva, G. and Khodorovsky, M., 2014. Evaluation of investor attractiveness of power-generating companies: special reference to the development risks of the electric power industry. Energy Production and Management in the 21st Century: The Quest for Sustainable Energy, 190, p.1199.
Jenkins, K., McCauley, D. and Warren, C.R., 2017. Attributing responsibility for energy justice: A case study of the Hinkley Point Nuclear Complex. Energy Policy, 108, pp.836-843.
Menkhoff, L., Sarno, L., Schmeling, M. and Schrimpf, A., 2012. Carry trades and global foreign exchange volatility. The Journal of Finance, 67(2), pp.681-718.
Srivastava, S. and Srivastava, D., 2010. Interest rate derivatives in Indian banks. Serbian Journal of Management, 5(1), pp.111-125.