1. What gives rise to the currency exposure at AIFS? 2. What would happen if Archer-Lock and Tabaczynski did not hedge at all? 3. 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. complete the spreadsheet.. 4. What happens if sales volumes are lower or higher than expected as outlined at the end of the case? 5. What hedging decision would you advocate?
ANS 1:
American Institute for foreign Study (AIFS) had two divisions.
1. The College division, 2. High School travel division. From the college division the students are sent to different parts of the world for semester long courses. From the second division the high school students as well as their teachers are sent for 1-4 week trips worldwide. More than 50000 students are sent out of the country each year on academic as well as cultural exchange programmes. For these two events AIFS requires different currencies other than American dollars.
When AIFS got major percentage of its revenue in American Dollars it has to expend most in Euros and British Pounds. If there will be any exchange rate volatility, there will be currency mismatch. This gives currency exposure at AIFS.
Ans-2
If Archer-Lock and Tabaczynski would not hedge at all, they had to face the below three risks. i) Bottom line risk: When there will be an adverse move of the exchange rate, there may be an increase in the cost base.
If dollar depreciates, they have to pay more for unit dollar of Euro. ii) Volume Risk: They have to buy foreign currency six months before keeping some predicted value of future sales in mind. If the actual value differs from the predicted one, there may be a chance of loss. iii) Competitive pricing risk: They fix their price through the catalog and once price is fixed it difficult to change the price even if there may be a depreciation of dollars. This may result in a huge loss to their business.
Ans-3:
Refer excel-sheet :QUES-3”
Ans-4:
Refer excel sheet: “4-Sales Volume 30000” and “4-Sales Volume 10000”
Ans-5
According to Tabaczynski, the probability of the times that one gains from how the hedging is done, is same as one may losing by doing so in the long run. Hedging by options is a better way to do so as in adverse situations you will only lose the premium amount you have paid. At the same time the company has not to pay any premium and may be benefitted by using futures, but there is a fear of huge loss that can be avoided by using options. So we will advice AIFS to hedge 50% with options and 50% with futures. In this hedging, the loss from the one type of hedging will be compensated by the other to some extent.
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