Case Study Essay – Hedging Currency Risks at AIFS
The American Institute for Foreign Study (AIFS) is offering cultural exchange programs for American students and High School pupils throughout the world. Their customers have the possibility to go abroad while the AIFS organises the whole trip for them. Due to their business model the revenues of the company are denominated only in USD, since the offer is for American students who pay in USD. Meanwhile the costs of the company is mostly denominated in foreign currency because AIFS has to pay the transport, the hotel and much more in the countries in which their customers are travelling, hence the firm has to pay in the local currency of these countries. In consequence of the fluctuating exchange rate of USD against foreign currencies and the fact that AIFS fixes the price for their services before the costs can be estimated, the firm faces an inevitable currency exposure. In order to limit or eliminate this risk, AIFS has to hedge their currency exposure. At the moment the company hedges 100% of their exposure using forward contracts and currency options. Now Becky Tabaczynski, CFO of one of the main divisions, is creating a model, including different scenarios, with the goal of identifying which proportion of the exposure should be hedged at all and in which proportion forward contracts and currency options should be used for hedging.
Not hedging at all could have disastrous consequences for the whole company because in the case of a weak dollar the costs could rise drastically while the revenues remain fixed. Suppose the company has fixed the prices for the current season and now the costs in Europe are one million euros, while the exchange rate is at 1.20 USD/EUR. This means the firm’s costs are 1.2 million dollar. If the dollar weakens against the euro and the exchange rates rises to 1.32 USD/EUR, costs for AIFS would increase by 10%. Thus costs would increase by The higher the costs turn out, the higher...
Please join StudyMode to read the full document