SUBMITTED BY 4th GROUP

NAMITA MALHOTRA
MANDEEP SINGH DASS
MANMOHAN SINGH
MOHIT SHARMA
NAVEEN JINDAL
MUDASIR MAQSOOD

HEDGING CURRENCY RISKS AT

AIFS:
Q1. What gives rise to the currency exposure at AIFS?

Ans: The AIFS organisation works in two programs. One is for semester

long program and the second for high schools travel division. The

organisation sends students abroad for exchange programs. Students are

selected according to their capabilities. The students are sent to America,

Canada and other countries.

As the business organise educational and cultural exchange programs

throughout the world, the revenue of the organisation comes in US

Dollars, but it incurs costs in other currencies mainly in Euros and Pounds.

The organisation has limited its flexibility to react to development in

currency market by giving a guarantee on the price in register, until the

publication of the next register.

Q2. What would happen if Archer-Lock and Tabaczynski did not

hedge at all?
Ans. If Archer-Lock and Tabaczynski didn’t hedge at all, it would be

exposed to currency risk. As the organisation engages in exchange

programs by sending students abroad for exchange programs, it incurs its

cost in Euros and pounds while the revenues are in US dollars.. There is

time lag between the agreement and payment. This may have positive

effect as well as negative effect. The organisation may benefit if the value

of Euro increases. So, the organisation will be able to increase their cost

base, while their revenue in USD will still be the same. This may result in

profits but if the value of Euro decreases, the organisation will have less

cost base and as a result, it may incur losses.

Q3. What would happen with a 100% hedge with forwards? A

100% hedge with options? Use the forecast final sales volume of

25,000 and analyze the possible outcomes relative to the ‘zero

impact’ scenario described in the case?

Ans. ‘Zero impact’ scenario for the expected sale volume of 25,000 and a

stable dollar rate of US$1.22/per euro would incur cost at the value of:

€1,000*US$1.22/€*25,000=US$30.5million

Strong dollar (US$1.01/€):

€1000*US$1.01/€*25,000=US$25.25million, creating a positive impact.

Weak dollar (US$1.48/€)

€1,000*US$1.48/*25,000=US$37 million, creating a negative impact.

Thus no hedge strategy and forwards incurred no additional expense,

where as the optional strategy would make AIFS pay an optional premium

of 5% of the USD notional value.

According to our viewpoint both the contracts are beneficial in one or the

other way, it only depends on the situations. both contracts have their

pros and cons. If we take a variable fluctuations, then if fluctuations are

high then it’s better to opt for option contracts to minimize our risk, but if

fluctuations are lower than its better to go for forward contract as to save

our 5% premium cost.

Q4. What happens if sales volumes are lower or higher than

expected as outlined at the end of the case?

Ans.

If sales volumes are lower

 • When the sales are low and the company is out of money, the

company has an excess of currency. The option contract is more

favourable in this situation.

• When the sales are the low and the company is in the money, the

forward contract is more favourable because option contracts costs

more.

If sales volumes are higher

• When the sales are higher and the company is out of money, option

contract is favourable because company has not to buy Euro at

higher rate.

• When the sales are higher and the company is in money, the

company loss is in difference on volume of sales and the increase of

the exchange rates.

Q5. What hedging decision would you advocate?

Ans. We would advocate forward contracts as the gain is larger with

forward contracts because it guarantees the amount of currency AIFS

would pay receive and is exempted from paying 5% option premium.

Moreover, it has maturity upto 1 year and sometimes longer.

Hedging strategy may also work.

In option strategy, we have to pay 5% premium. The forward contract is a

good option as the company is limited on cash and May not able to pay

advance premium.