Hedging Currency Risks at AIFS
1. The final sales volume and the final dollar exchange rate gives rise to the currency exposure risk. Prices are set 1 year ahead of time so any fluctuation in the exchange rate will potentially cause a loss or savings to AIFS when the currency is exchanged.
2. If the exchange rate remains constant at $1.22/euros then AIFS will not incur a loss or a gain. It would cost $1220 per participant at this exchange rate. If actual dollar costs were above this level, then there would be a negative impact. If actual dollar costs were lower than expected, the impact would be positive. Thus, with a sales volume of 25,000 participants and the exchange rate rises to $1.48/euros then AIFS will be subject to a loss of $4,391,892. If the exchange rate drops to $1.01/euros then AIFS will save $5,198,020.
3. With a 100% forward hedge under a final sales volume of 25,000 participants, AIFS is facing a dollar inflow of $25,000,000. Under this assumption, the optimal amount of expenses would be 1000 Euros per student. Risk arises when currency rates between the Euro and the dollar fluctuate. From the European perspective, there is 25 million Euros in underlying exposure. If 25 million Euros were bought forward at the 1.22 $/euro rate, then 30.5 million dollars will be sold. If the contract was signed in June 2004, then 1 year 30.5 million dollars can be spent for 25 million Euros, leaving a net position of 0 Euros and 30.5 million dollars (100% forward hedge). With this forward hedge, AIFS is completely mitigating the exchange rate risk between the dollar and the Euro, and are thus protected from losing money if the exchange rate approaches 1.48$/Euro. With a 100% option hedge,
4. The higher or lower sales volume would exaggerate whatever gains or losses AIFS will realize. We are able to utilize the AIFS shifting box to determine what the reactions to differing sales volume versus the exchange rate. If the volume is low...
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