RISK MANAGEMENT

GROUP PROJECT

DECEMBER 5, 2023

ANAHITA HAMZEH
FAUZIA SABRINA AHMED
ION ANDREI ALEXANDRU
NICOLE GEORGIANA ILIE
IULIA MIHAELA HASCU
ECATERINA GEAVELA
 Problem 1

1. By looking at the OLS-generated regression analysis in EViews, we can see that only
𝜷2 and 𝜷3 are statistically significant, as their p-values are lower than 0.05 (0.0000
for 𝜷2 and 0.0001 for 𝜷3).
Moreover, it can be observed that 𝜷4 is larger than 0.05, and thus can be determined
as statistically insignificant.

2. The coefficient value is used to signify how much the mean of the dependent variable
changes given a one-unit shift in the independent variable, while holding other
variables in the model constant.
It is extremely crucial to take into consideration and make sure the other variables are
held constant because it allows you to assess the effect of each variable in isolation
from the others. 𝜷1 has a p-value of 0.0497, lower than 0.05, therefore it is
statistically significant.
 3. Hyphothesis testing:
- H0: 𝜷1, 𝜷3 and 𝜷4 = 0.
We used a 5% significance level and the decision rule was the following: is 𝜷^ is significantly
different from 𝜷1, 𝜷3 and 𝜷4?
This suggests that the estimate of β significantly improves the model fit and the variable is
significant. If the test findings could not reject the null hypothesis, it suggests that removing
the variables from the model will not significantly affect the model's fit. In this scenario, we
reject the null hypothesis and can so conclude that the coefficients are significantly different
from 0.
4. We first specified an AR(1) model in order to test for ARCH effects. In this scenario,
the null hypothesis would be H0: no ARCH effects. We used OLS to estimate a mean
equation for the dependent variable, then saved and squared the residuals. Finally, we
ran a Lagrange Multiplier test. In this scenario, 𝜷2 is significant at the 5%
significance level, allowing us to reject the null hypothesis and infer that ARCH
effects exist. Finally, to estimate the ARCH model, we look at the variance equation,
which gives the result. The time-varying volatility consists of a constant and a
component based on previous errors (128.3699 and 0.117587, respectively).
 Problem 2

Thinking of the origins of financial derivatives, we discovered that these can be traced
back centuries to economic practices in which merchants have constantly used contracts to
hedge against market risks (Hull, 2017). Some such examples include merchants protecting
their holdings using the futures contracts, which is easily comparable to ancient farmers
protecting crops (Black & Scholes, 1973).
Futures markets were not limited to agricultural products in the early twentieth century;
they started encompassing financial items. The founding of the Chicago Mercantile Exchange
(CME) in 1919 also known as the CME has been a remarkable event. (Harris, 1970)
Economists like John Maynard Keynes made the foundation on which economists developed
understanding about theories related to these contracts. Nonetheless, the modern form of a
futures market in its contemporary sense emerged gradually in the nineteenth century that led
to the emergence of centralized exchanges. CBOT was established in 1848 and it became one
of the pillars that laid the foundation for organized futures trading. (Saleuddin, 2018)
Wizz Air, a Hungarian low-cost airline, flies within Europe as well as into the Middle
East, North Africa. Within a short period since this company was founded in 2003, it is now
the leading airline in this region as well as the largest with the highest market share among
the central and eastern European carriers (Information & Services, Investor information,
results & calendar, 20 The company uses different derivatives to mitigate any form of risk
related to changes in fuel prices and foreign exchange rates thereby making its operations
more predictable and gives the business more budget certainty (WIZZ AIR HOLDINGS
PLC, 2023).
A thorough analysis of currency and fuel hedging strategy employed by Wizz Air
should delve into the complexities of the issue. A significant feature is that the company
switched towards increased hedging, and this is consistent with the general situation where
there is greater realization that companies should undertake risk management to minimize
adverse effects of the unstable economic environment (Smith, 2019).
Wizz Air uses derivatives as a hedging tool against price and currency exchange rate
variations. Contracting financial institutions estimate the fair value of the derivatives based
on their industry practices. Management also uses hi level models to confirm the values
ascribed to those instruments as per requirement. This is computed using the average market
price observed between the commencement and end of year. (WIZZ AIR HOLDINGS PLC,
2023).
Starting with the fiscal year that concluded on March 31, 2018, the company began
steadily increasing the sum of funds allocated to its hedging strategy (WIZZ AIR
HOLDINGS PLC, 2018). In order to effectively manage a budget as a low-cost airline,
protection against the volatility of particular currencies and commodities is critical. We are
going to look at Wizz Air's currency and fuel hedging strategy in the next years, as well as
the impact of that plan on the firm during COVID-19.
The corporation plainly offers three major financial risks against which they believe
substantial safeguards must be implemented. These dangers include changes in commodity
prices, currency rates, and interest rates. In 2018, the company used a few hedging products
to limit the risk of commodity price (fuel) and currency rate fluctuations. The interest rate
risk is also regarded as a significant issue.
The business is subject to risks regarding foreign exchange rates when it comes to sales,
purchases, and obligations that are valued in currencies other than euros. Because the bulk of
its sales are in euros and the majority of its expenses (fuel, leases, maintenance reserves, and
insurance) are in US dollars, the company is exposed to a great deal of risk in this situation.
Furthermore, the British Pound and Polish Zloty are two currencies in which the corporation
reports larger revenues than expenses, as stated in its 2018 Annual Report. As a result, it is
critical that the business safeguard itself against the danger of variations in exchange rates.
Given the backdrop data, the company's foreign exchange rate hedging strategy
currently centers mostly on the EUR/USD pair. The corporation decided to hedge the foreign
currency rate between GBP and EUR during the same period. To reduce any short-term
volatility, the company started hedging its major non-EUR revenue currency, GBP, against
EUR in the 2017 fiscal year. Unlike the US Dollar, there is no minimum coverage
requirement for GBP; the maximum is 60% of anticipated net GBP exposure on a rolling 12-
month basis. The goal of the hedging strategy was to reduce short-term fluctuations in
liquidity and earnings. Wizz Air hedges at least 50% of the projected US Dollar and jet fuel
requirements for the next 12 months, and 40% for an 18-month hedge horizon. (WIZZ AIR
HOLDINGS PLC, 2018).
Fuel is a substantial expense on Wizz Air's complete revenue statement. Fuel accounted
for EUR 480 million, or about 29% of all operating expenses, according to the company's
2018 report. The potential volatility of fuel prices can significantly impact the
competitiveness of the company in the market, given its objective to expand and sustain itself
as a profitable low-cost carrier. Fuel hedging is a crucial approach that allows the corporation
to purchase a substantial portion at set cost (703,000 metric tons in 2018), with the remaining
portion being purchased at market pricing.
We saw a minor decline in the total hedged proportion in 2019—from 55% to 54%. We
did observe a 55% foreign exchange hedge coverage for GBP, though. The first two months
of the fiscal year 2020, May and June 2019, were the only months for which open hedges
were in effect during this time. Furthermore, we observed a slight decline in fuel hedging as
well. This implies that the business may have used a more conservative hedging approach at
that time. Similarly, as in the previous year, the minimum variance hedge ratio has been met
(WIZZ AIR HOLDINGS PLC, 2019).
A company's ability to hedge against market risks, such as changes in commodity prices
or currency fluctuations, is limited by a weighted average ceiling. We note that the average
ceiling for WizzAir had a slight reduction in 2019 (WIZZ AIR HOLDINGS PLC). As a
result, there is less market risk and more forecast certainty. The corporation might not need to
hedge as much of its exposure if its exposure to market risks has diminished.
The impact of COVID-19 in 2020 was expected to significantly reduce the capacity of
jet fuel to be used in the first half of the fiscal year 2021 compared to the program's baseline,
and certain hedging instruments were no longer correlated with future jet fuel purchases.
Hedge accounting for these derivatives has thus been gradually discontinued. The losses were
categorised as "discontinued hedges" and recorded as an unusual operating expense on the
income statement. (WIZZ AIR HOLDINGS PLC, 2020).
The amount of derivatives registered as assets in that year's financial statement shows a
notable drop of EUR 13.2 million when compared to 2019. The entire amount of EUR 307.8
million in registered derivative financial liabilities for that year was related to fuel hedges,
whereas the hedge receivables were exclusively associated with FX hedge instruments.

Examining the report, we also see that Wizz Air claims to have changed the value of
currency purchases and ended its fuel hedging programme in several chapters.

The 2021 numbers support the more cautious approach outlined in the 2020 report.
While the total volume of derivative financial assets dropped to EUR 13.1 million yet again,
this year's hedge receivable balances were concentrated on fuel hedge instruments, indicating
that the company concentrated on growing its activity while exercising caution.

The Board of Directors decided in June 2021 to adopt the Company's "no hedge" policy
for the post-COVID-19 period with regard to US Dollar and jet fuel price risk after carefully
analyzing the financial benefits and drawbacks of the hedging programme. Three primary
justifications were given for this decision: the Group's balance sheet is stronger than it was at
the beginning of the hedging programme; it is less vulnerable to increases in input prices than
some of its industry competitors due to the shorter booking window; and, in comparison to
other competitors, it has a lower competitive overlap of operating routes. (WIZZ AIR
HOLDINGS PLC, 2021).

The Company experienced significantly lower activity levels in 2021 as a result of the
COVID-19 outbreak, and as a result, lower fuel consumption than was initially estimated
when the hedging strategy was implemented, according to the 2022 Annual Report. As a
result, some of the derivatives' hedge accounting was stopped. Due to the travel restrictions
and decline in demand for voluntary travel, Wizz Air made the decision to discontinue
hedging against the US dollar and jet fuel in September 2020 in order to reduce the risk of
over hedging. Thus, Wizz Air kept up its new hedging approach in 2022.
In 2023, Wizz Air went on adopting some of the lessons it had learned in 2022. The
company recorded a increment of 0.5 million euros in fuel hedge instrument derivatives
financial assets from 2022. (WIZZ AIR HOLDINGS PLC, 2023). As mentioned before, in
2022, it was notable that the firm decided to stop hedging against the US dollar and jet fuel.
This effected the following year. Since 2023 lacks discontinued hedges and exceptional
items, it reveals a much stable financial strategy. These financial instruments were
strategically employed by management to establish their impact on the jet fuel price, foreign
exchange rate, their implied volatility and yield in determining non-IFRS underlying loss
measure for the Group (WIZZ AIR HOLDINGS PLC, 2023). Wizz Air’s evolution of its
financial strategies is indicative that it moved from a reactive stance in 2022 to a more
proactive and polished approach in 2023.
In conclusion, using derivatives to hedge against financial risks can be helpful, but it
can also result in financial difficulties if there are unforeseen changes in the market, as Wizz
Air experienced after the COVID-19 pandemic. To decide on its risk management plan, the
business must consider the advantages and disadvantages of utilizing derivatives.

References:
Bartram, S. M. (2019). Corporate hedging and speculation with derivatives. Journal of
Corporate Finance, 57, 9-34.
Black, F., & Scholes, M. (1973). The Pricing of Options and Corporate Liabilities.
Journal of Political Economy, 81(3), 637-654.

Harris, E. (1970). History of the Chicago Mercantile Exchange. Futures Trading in

Livestock–Origins and Concepts, Chicago: Chicago Mercantile Exchange, 49-54.

Hull, J. C. (2017). Options, Futures, and Other Derivatives. Pearson.

Information & Services, Investor Information, Results & Calendar. (2023, December
1). Retrieved from Wizz Air:
https://wizzair.com/en-gb/information-and-services/investor-relations/results-
calendar

Information & Services, Investor Information, Traffic Statistics. (2023, December 1).
Retrieved from Wizz Air:
https://wizzair.com/en-gb/information-and-services/investor-relations/investors/
traffic-statistics

Saleuddin, R. (2018). The Government of markets: How interwar collaborations

between the CBOT and the state created modern futures trading. Springer.

WIZZ AIR HOLDINGS PLC. (2018). Annual Report and Accounts 2018.

WIZZ AIR HOLDINGS PLC. (2019). Annual Report and Accounts 2019.

WIZZ AIR HOLDINGS PLC. (2020). Annual Report and Accounts 2020.

WIZZ AIR HOLDINGS PLC. (2021). Annual Report and Accounts 2021.

WIZZ AIR HOLDINGS PLC. (2022). Annual Report and Accounts 2022.

WIZZ AIR HOLDINGS PLC. (2023). Annual Report and Accounts 2023.