This case shows us the problems faced by AIFS due to the fact that it receives most of its revenues in US-Dollars but with its costs incurred in foreign currencies (Euros and Pounds). AIFS uses currency hedging to protect their bottom line and to cope with changes in exchange rates which can increase cost base and also purchase foreign currency based on projected sales volume because they don’t know what future sales volume will be. In the event of the above risks, Tabaczynski considers three alternative strategies with diiferent exchange levels with the price of each hedging strategy incorporated in the calculations.
The AIFS is a company that organises educational and cultural exchange programs for students. It receives most its revenues in US-$, while the costs mostly incure in Euros and British Pounds.
So AIFS must hedge thes currencies to protect its business model.
But AIFS faces two severe problems in their hedging activities: What percentage of the unsure/forecasted demand should be covered and what the right instrument (options or contracts) in what proportions.
The general policy of AIFS is to cover 100 % of the forecast and match the option percentage to the perceived volume risk.
The aim was now to have a spreadsheet that models the risks better. This more comprehensive spreadsheet covers different scenarios of demand and of the exchange rate, above all it accounts the price of hedging.
The focus of this case study lies on the American organization AIFS and its challenges in hedging foreign currency risks. More than 50,000 students participate each year in exchange programs of AIFS, which leads to annual revenues of around $ 200 million. As the catalog prices in USD have to be fixed and guaranteed more than one year before the costs in foreign currencies have to be paid, AIFS is hedging currency risks by forwards and options.
Mrs. Tabaczynski (CFO) and Mr. Archer-Lock (controller) are always in search of the best solution for hedging the 3 main risks of the group: - risk of increase of cost base by adverse change in exchange rates - risks in projected versus actual sales volume
- risk in competitive pricing due to AIFS’s promise of fixed prices, which excludes the possibility of transferring rate changes into price increases Therefore Mr. Archer-Lock developed a two-by-two matrix, which includes 4 different business cases depending on the proportion of the two key factors for successful hedging – sales volume and exchange rate. Based on this matrix Mrs. Tabaczynski set up a spreadsheet to calculate different hedging strategies and identify their consequences by variation of the hedging ratio (e.g. 0 %, 25 %, … hedge in forwards; 100%, 75 %, … hedge in options, no hedge) and different exchange rate scenarios. The model of Mrs. Tabaczynski will help in evaluating the risk of the different strategies and in making a decision. •
The corresponding case study decribes the challenges for the AIFS – a US company specialized on college and high school exchange programs for travelling abroad – of hedging currency risks due to their catalog based business model. AIFS with its annual group turnover of around $200 millions is a well known and established competitor in its markets with a high customer loyality which is not at least generated by their promise of fixed prices. As the company has to plan their Dollar catalog prices more than one year in advance while the costs for the students incurred mainly in foreign currencies (mostly EUR and GBP) up to one year later the company already uses forwards and options to hedge these risks, but there are still other unforeseeable threats by international or economical crisis influencing sales and earnings.
The two responsible persons, Mr. Archer-Lock (London based controller of AIFS) and Mrs. Tabaczynski (CFO of AIFS in Boston), were always concerned...
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