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 didnt 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 its 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.