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Internation

al financial
Manageme
nt
Assignment AIFS
Question no. 1
What gives rise to the currency exposure at AIFS?
The factors that give rise to currency exposure at AIFS are:
1. Nature of the business
2. Strategy
3. Time schedule of setting prices
Lets discuss them all one by one.
Nature of the Business:
American Institute for Foreign Study is a student exchange organization that organize student
exchange program for American university aged students who want to study in abroad for a
semester. AIFS also organize foreign study trips for American High School Students. The nature
of business is natural as its revenues are always collected in USD (US Dollar home currency) as
the organization is serving the Americans while its expenses are incurred in foreign currency as
organization is serving the American students by seeking services in abroad. This natural nature
of business give rise to the currency exposure.
Strategy:
In order to retain its loyal customer base and in order to keep them from price surprises, the
organization has a policy of fixed prices between the span of its catalogs relative to costs. The
business strategy of AIFS is like that it has two divisions. One division is responsible for
organizing trips for high school students while other division is responsible for organizing
student exchange programs for the university aged students. For marketing purpose and creating
awareness about different programs offered by AIFS, its division issues catalogs (university
students two main catalogs in a year and for school students one main catalog). The strategy of
the AIFS is to keep the prices constant till the new catalog is issued, no matter if costs are
increasing the prices would remain same. This strategy also arises currency exposure at AIFS as
now the exchange rate fluctuations cannot be adjusted through price increment as they are fixed
for a span of time.
Time schedule of setting prices:
Due to the strategy of guaranteed prices during two catalogs, the prices setting takes place
infrequently exposing the AIFS towards currency exposure as prices are increasing on the lower
pace with respect to expenses that are incurring in foreign currency and involved uncertainty
regarding currency exchange rate.

Question no. 2
What would happen if Archer-Lock and Tabaczynski did not hedge at all?
A. The table below demonstrates three different outcomes if AIFS did not hedge its currency

positions.

If Dollar Remains Stable $1.22


$1.22 * 25,000 units *1000 euro $30,500000
Cost Per Student (@$1.22, or $1,220 per student is company projected cost) $1,220.00

If Dollar Becomes Weak $1.48


$1.48*25000 units *1000 euros $37,000,000
Cost Per Student $1,480.00

If Dollar Becomes Strong 1.01


$1.01*25000 units*1000 euros $25,250,000
Cost Per Student $1,010.00

As can be seen from the above table, three different outcomes would be produced from the given
case data. The stable rate is $1220 per participant that we refer to as base case. If the exchange
rate $/Euro increases ($1.48/euro) then the AIFS would have loss as cost per participant
increases to $1480 per participant. But if the $/euro decreases as $1.01/euro then the expense per
participant is $1010.
Question no. 3
What would happen with a 100% hedge with forwards? A 100% hedge with options? Use the
forecast final sales volume of 25000 and analyze the possible outcomes relative to the zero
impact scenario in the case.
Answer: The cost with 100% hedge with forwards is
1000*25000*1.22= $30500000
The cost with 100% options is
1000*25000*1.22+ (1000*25000*1.22*.05) = $32025000
If exchange rate becomes $1.01.euro:
In this case, the base case, if AIFS hedged at $1.22 (the strike price) at a cost of 105% ($1.28)
and the cost of the euro declined to $1.01 then AIFS would benefit due to greater buying power
of the dollar vs the euro. In this case we recall that AIFS projected company cost was $1.22 per
euro. AIFS paid $1,525,000.00 to obtain this option which they will not exercise, and will buy
the euro on the open market instead. AIFS incurred a cost of $1,525,000.00 when they purchased
this option. The transaction will make the profit like this take place like this:

If option exercised the amount has to pay for buying euros will be = 1000*25000*1.22=
$30500000

Buy Euro on open market 1000*25000*$1.01/euro= $25250000

Premium paid for option =1.22*.05*1000*25000 = $1525000

Profit for favorable exchange rate move =$30500000-$1525000-25250000 = $3725000

If Exchange Rate moves to $1.48/euro:

If AIFS hedge with options and exchange rate becomes $1.48/euro while the option will be
exercised with $1.22/euro. AIFS will exercised the option and will eliminate its exchange rate
exposure. The transaction will be take place like this:

The calculation for loss is also given:

The exercise option will cost AIFS = 1000*25000*1.22= $30500000

If not hedged at all the cost will be

1000*25000*1.48= $37000000

The amount save through hedging with options is =


37000000-30500000-1525000=$4975000
Question no. 4
What happens if sales volume are lower or higher than expected as outlined at the end of the
case?

If Dollar Remains Stable $1.22


$1.22 * 30,000 units *1000 euro $36600000
Cost Per Student (@$1.22, or $1,220 per student is company projected cost) $1,220.00

If Dollar Becomes Weak $1.48


$1.48*30,000 units *1000 euros $44,400,000
Cost Per Student $1,480.00

If Dollar Becomes Strong 1.01


$1.01*30,000 units*1000 euros $30300000
Cost Per Student $1,010.00

The cost per student is same while in total it will change. The volume risk is related to the
volume of the sales and not with currency risk. So the results and strategy will be same for
currency hedging because this volume risk cannot mitigated through hedging that is no matter
which currency hedging option one use the result would be same as it is a volume problem not
currency problem.
Note: For total cost analysis in different sales volumes, refer to excel sheet please.
Question no. 5
What Hedging decision would you advocate and why?
My Hedging decision is depended upon the following analysis:

Cove Forward
r in Contract Option $1.01/e $1.22/e $1.48/e
% s s uro uro uro
If 100 AIFS cover all the expense
by % 0% 100% 1.06 1.28 1.55 hedging and then the
100 lowest cost is $1.24/euro
% 25% 75% 1.05 1.27 1.54
100 that is coming with 25%
% 50% 50% 1.04 1.25 1.52 options and 75% forward
100 contract. Surely this is a
% 75% 25% 1.02 1.24 1.50
good option after 100%
100
% 100% 0% 1.01 1.22 1.48 forward. I have preferred
this option because it is
giving AIFS flexibility to take advantage of favorable exchange rate up to 25% of amount
hedged. Moreover, apart from this strategy going with more percentage of options will provide
the company more flexibility to deal with favorable exchange rate but also will add up to the
premium cost for the company.