PLEKHANOV RUSSIAN UNIVERSITY OF ECONOMICS
INTERNATIONAL BUSINESS SCHOOL
HEDGING CURRENCY RISKS at AIFS
Master’s Degree Students:
Supervisor: Yulia Finogeeva
INTRODUCTION AND PROBLEM STATEMENT
AIFS is an American based company which was found in the U.S. in 1964. There are two main divisions in the company: the College division, which offers study abroad programs for American college students and High School travel, which organizes educational travel abroad to high school students. AIFS receives the main part of its revenue in American Dollars (USD), but because of the type of its activity, most of its expenditures are in other currencies such as Euros (EUR) and British Pounds (GBP). AIFS pricing for the College division is based on the academic planning year, from July 1 to June 30. Therefore, for this division hedging begins in early July. The pricing for High School travel division is based on a calendar year basis from January to December and hedging take place throughout the year. Also, AIFS guarantees that prices would not change before the next catalogue would be sent out, which provides the company customer loyalty. AIFS uses currency hedging in order to manage three types of risks which the company faces during their performance: bottom line risk, volume risk and competitive price risk. Bottom line risk is connected with the possibility of exchange rate fluctuations. The company’s prices are fixed in USD currency, and if for example pound appreciates against dollar, the company will face losses. Volume risk occurs because the sales are projected in advance, and the real sales can differ from the projected ones. This risk mainly has a certain attitude towards High School travel division, since its customers reacts immediately to the world cataclysms, currency exchange fluctuations, wars etc. Such news can affect AIFS’ sales up to 60%. Competitive price risk occurs because of the company’s policy not to change the pricing strategy for the whole year. It positively affects customer loyalty, because 70 % of the company’s clients are returning customers. However, it gives the company little space to conduct a maneuver in case of exchange rate fluctuations. If the exchange rates changes, AIFS does not have a possibility to adjust its prices to the current situation. It can be concluded that foreign exchange hedging is of a big importance for the AIFS as the company faces different types of risk that occurs from its activity. In order to reduce these risks, it is necessary for the company needs to understand – what percentage of the risk is necessary to cover and in what proportions should AIFS use forward contracts and put options to sell dollars.
Initially, the analysis will be based on the assumption of Tabaczynski. It is assumed that the expected final sales volume is 25 000. There are three scenarios that should be analyzed: stable dollar (1,22 USD /EUR), strong dollar (1,01 USD /EUR) and weak dollar (1,48 USD /EUR). Three alternative strategies have been determined already – do not hedge, 100 % hedging with forwards, 100 % hedge with options.
NO HEDGE STRATEGY
Let’s consider the “no hedge” strategy. If the company chooses not to hedge their risk, there are three possible outcomes. First one, if the dollar will be stable, the company will receive “impact zero” scenario with no lose and no gain. If the dollar strengthens, AIFS will receive gain of $ 5 250 000 (1,22 x 25 000 000 – 1,01 x 25 000 000). However, if the dollar weakens, the company will face losses of $ 6 500 000 (1,22 x 25 000 000 – 1,48 x 25 000 000). There is a likelihood for the company to make revenue, however, the possibility of exchange rate fluctuations is higher than the possibility that dollar will remain stable....
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