Group-Case-No.-3-CITIC-Pacific.pdf - CITIC PACIFIC Foreign...

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Chapter 18 / Exercise 18.2
Cengage Advantage Books: Foundations of the Legal Environment of Business
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CITIC PACIFIC: Foreign Exchange Scandal 1 Case Overview In February 2008, CITIC Pacific’s (CP) stoc k price sat at a high of HK$43. But within a mere 8 months, it plunged by 92 per cent to HK$3.66 after a foreign exchange scandal which led to a loss of some US$2 billion. This loss was attributed to the unauthorised betting on foreign exchange derivative contracts that were supposedly hedges against currency risks. The objective of this case is to allow a discussion of issues such as board composition, risk management, executive compensation and other corporate governance practices. Unauthorised Bets on Foreign Exchange Derivative Contracts CP’s investment in a Western Australia i ron ore mining project involved an estimated capital commitment of A$1.6 billion and €85 million 2 . In addition, annual operating expenditure of at least A$1 billion for up to 25 years was projected. CP’s cash projections were denomin ated in USD, but these expenses were paid in Australian dollars and Euros, thus exposing CP to fluctuations in foreign exchange rates. To hedge against these risks, CP entered into contracts to deliver USD in return for AUD and EUR. These actions were common to mitigate business risks. The unique problem faced by CP, however, arose from its use of “foreign exchange accumulators”. Accumulators, including currency target redemption forward contracts and daily accrual contracts, were employed by CP. Unlike regular derivatives, accumulators have a unique characteristic: the knock-out clause. The knock-out feature causes the contracts to expire once CP achieves a stipulated profit from the contracts. While the upside gain of the hedging instrument was confined, losses could be unlimited, thus resulting in an asymmetrical payoff. 1 This is the abridged version of a case prepared by Clara Chua, Clarice Koh, and Low Wai Ling under the supervision of Professor Mak Yuen Teen. The case was developed from published sources solely for class discussion and is not intended to serve as illustrations of effective or ineffective management. Consequently, the interpretations and perspectives in this case are not necessarily those of the organisations named in the case, or any of their directors or employees. This abridged version was prepared by Amanda Aw Yong under the supervision of Professor Mak Yuen Teen. Copyright © 2012 Mak Yuen Teen and CPA Australia 2 CITIC Pacific. “Profit Warning”, 20 October 2008, <. com/upload/en/20081020-2e.pdf>
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Cengage Advantage Books: Foundations of the Legal Environment of Business
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Chapter 18 / Exercise 18.2
Cengage Advantage Books: Foundations of the Legal Environment of Business
Jennings
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