Aifs Case Notes
How does AIFS make money?
Aifs is long in dollars and short in Euro’s. (has dollar revenues and euro costs)
What happens when the dollar appreciates/depreciates?
What is the currency risk? Why can’t they just pass-through to their customers?
For simplicity in calculations: Focus on the $/€. Ignore the time value of the investment in the option premium.
Analysis
Provide background to the case: what the company does, how it sets prices, why they don’t pass-through exchange rate volatility to customers.
Examine Page 6 of the case closely:
Define the base case scenario: Volume = 25,000 students & cost per student is €1,000.
Assume no hedging: Estimated cost is :
• 25000*1000*1.22 = $30.5 million
• 25000*1000*1.01 = $25.25 million (windfall of $5.25 million)
• 25000*1000*1.48 = $37 million (“surprise” of $6.5 million)
Assume 100% forward hedge at $1.22
• 25000*1000*1.22 = $30.5 million locked in
Assume Call option
• Premium = (25000*1.22*.05) = $1.525 million
o If rate is $1.01 then option is not exercised & cost is: 25000*1000*1.01 = $25.25 + premium = $26.775 (windfall = (30.5 – 26.775 = $3.725 million)
o If rate is $1.22 then indifferent to exercise & cost is 25000*1000*1.22 = $30.5 + premium = $32.025 (added cost due to option premium)
o If rate is $1.48 then option is exercised at strike of $1.22 & cost is $32.025.
• Analyze various alternatives assuming intermediate ranges for mix of forward and options covers (e.g. 25% forward cover and 75% options cover)
Next Step
AIFS does not know how much foreign currency it needs because they don’t know with certainty what the volume of sales will be.
Redo your calculations assuming that volume is 10,000; 30,000, 40,000 & differs from the 25,000 volume forecast.
Start with the no hedge alternative since this is easiest to calculate.
Next assume 100% cover of the projected volume of 25000
Aifs is long in dollars and short in Euro’s. (has dollar revenues and euro costs)
What happens when the dollar appreciates/depreciates?
What is the currency risk? Why can’t they just pass-through to their customers?
For simplicity in calculations: Focus on the $/€. Ignore the time value of the investment in the option premium.
Analysis
Provide background to the case: what the company does, how it sets prices, why they don’t pass-through exchange rate volatility to customers.
Examine Page 6 of the case closely:
Define the base case scenario: Volume = 25,000 students & cost per student is €1,000.
Assume no hedging: Estimated cost is :
• 25000*1000*1.22 = $30.5 million
• 25000*1000*1.01 = $25.25 million (windfall of $5.25 million)
• 25000*1000*1.48 = $37 million (“surprise” of $6.5 million)
Assume 100% forward hedge at $1.22
• 25000*1000*1.22 = $30.5 million locked in
Assume Call option
• Premium = (25000*1.22*.05) = $1.525 million
o If rate is $1.01 then option is not exercised & cost is: 25000*1000*1.01 = $25.25 + premium = $26.775 (windfall = (30.5 – 26.775 = $3.725 million)
o If rate is $1.22 then indifferent to exercise & cost is 25000*1000*1.22 = $30.5 + premium = $32.025 (added cost due to option premium)
o If rate is $1.48 then option is exercised at strike of $1.22 & cost is $32.025.
• Analyze various alternatives assuming intermediate ranges for mix of forward and options covers (e.g. 25% forward cover and 75% options cover)
Next Step
AIFS does not know how much foreign currency it needs because they don’t know with certainty what the volume of sales will be.
Redo your calculations assuming that volume is 10,000; 30,000, 40,000 & differs from the 25,000 volume forecast.
Start with the no hedge alternative since this is easiest to calculate.
Next assume 100% cover of the projected volume of 25000