Aifs Case

Topics: Forward contract, Futures contract, United States dollar Pages: 3 (587 words) Published: December 26, 2012
* AIFS Shifting Box: the relationship between final sales volume & market value of USD as well as their impact on AIFS’s hedging activities. * Square 1: the sales volume comes lower than expected thus AIFS has a surplus of currency. In addition, the exchange rate depreciates, so we cannot sell out the surplus currency at favorable price. It’s even worse if AIFS locked into surplus forward contract. * Square 2: AIFS also has the surplus of currency, but the exchange rate is now higher than expectation. Thus, the sales of currency may compensate for the lower sales volume. * Square 3: the sales volume is higher than expected, so AIFS runs out of currency. At the same time, the market value of USD is higher than expected, for example, 1.01 instead of 1.22. If the AIFS engaged in option, they can choose not exercising the option and buy total volume they need at the spot rate. This is the most favorable case. Even if AIFS engaged in forward contract, they can just buy the extra volume at the spot rate favorably. * Square 4: The good news is that sales volume comes higher than expected but AIFS has to buy extra currency at high exchange rate since the USD is now weaker. * 2 main questions relate directly to the hedging strategy of AIFS is that “What percentage of the expected costs should they cover?” and “ In what proportions should AIFS use forward contracts and options?” * First question: The percentage that AIFS should cover is driven mainly by the bottom-line risk or the fluctuation of exchange rate. Currently, AIFS hedge 100% of its expected requirements. If AIFS reduces the percentage to 75%, they may suffer the loss when the sales volume came higher than expected or the exchange rate increases and vice versa. The exchange rate movement graph below shows that the USD is more likely to become weaker compare with the euro. Thus, in coming year, AIFS should cover 100% of its expected cost. * The second question will be answer after the...
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