Cases in International

Finance
Hedging Foreign Exchange Exposure

Case #1: Lufthansa

If Karl Marx could see what the foreign exchange

market is doing to captains of industrya successful
corporate executive of one of the worlds prestige
airlines can put on a multimillion dollar currency
speculation and win and still get lambasted by the
critics. Its enough to make a capitalist cry!
Intermarket, 1985

Some interesting Facts

1926: Lufthansa was born through
the merger of Deutsche Aero Lloyd
and Junkers Luftverkehr it inherits
its crane logo from DAL
1934: Lufthansa offers its first
transatlantic flight
1990: Lufthansa resumes flights to
Berlin following German unification
1990: Lufthansa joins the star alliance
with Air Canada, SAS, Thai Airlines and
United Airways the first multinational
airline grouping

Lufthansa Today
Lufthansa is the national carrier of Germany
headed by Wolfgang Mayrhuber (since 2003)

Revenue (2004): E 17B

Net Income (2004): E 383M
Passengers (2004): 50.9M
Load Factor (2004): 74%
Lufthansa has 253 aircraft with an average age of 10.5 years.
Boeing: 40%
Airbus: 60%

In January 1985, under the Chairmanship of Heinz Ruhnau,

Lufthansa purchased twenty 737 jets from Boeing for $25,000,000
apiece ($500M Total)

Length: 100 Feet

Wingspan: 86 Feet
Cruising Speed: 470 MPH
Max Altitude: 35,000 Feet
Range: 1000 Miles
Seats: 123

At the time, the exchange rate was DM 3.20 per dollar. At this
rate, the planes would cost Lufthansa DM1.6B

Over the previous year, the dollar had been appreciating against
the Deutschmark..

Lufthansas Options
Option #1: Remain Uncovered
The riskiest option with the greatest potential gain (if the dollar
weakens against the Deutschmark) and the greatest potential cost (if the
dollar strengthens).
Option #2: Full Forward Hedge
The safest of the options. If Lufthansa bought dollars forward at
the current rate of 3.2, they could lock in a cost of DM1.6B
Option #3: Option Hedge
If Lufthansa purchased put option on DM at 3.20 DM/$ (or call
options on dollars), they could take advantage of the potential gain from
a dollar depreciation, but still hedge the possible appreciation risk

Lufthansas Options
Option #4: Money Market Hedge
Lufthansa could obtain dollars now, by borrowing Deutschmarks,
converting them to dollars at DM 3.20 and then depositing them in either a
US bank or a Eurodollar account until needed. In principle, this should
have the same effect as the forward hedge
Option #5: Partial Hedge
Lufthansa could purchase $250 M dollars forward at DM 3.20 at
allow the remaining balance to be un-hedged.
Option #6: Cash Flow Matching
Lufthansa could try and generate $500M in ticket sales in the US
very unlikely!

Lufthansas Options
Uncovered
Full Forward

Option Hedge
Partial Hedge

Ruhnau was convinced that the dollar was going to fall and opted for
the partial hedge. He was proved right as the dollar plummeted in the
mid eighties.

Did Ruhnau make the right decision?

Alternative
Uncovered
Put Options
Partial Hedge
Full Forward

Relevant Rate
DM 2.30
DM 2.30 + Premium
.5(2.30) + .5(3.20)
DM 3.20

Total Cost
DM 1.150 B
DM 1.246 B
DM 1.375 B
DM 1.6 B

While Ruhnau was correct on the direction of the dollar, he could

have saved some money using options rather than a partial hedge!

Case #1: Porsche

Porsche makes most of its cars in Germany,

so its costs are mainly in Euro. Yet a large
chunk of its revenues come from sales in
America.
The Economist, June 5, 2003

Some interesting Facts

Porsche was founded in 1931 by
Ferdinand Porsche, a former
Daimler Benz director.

One of the first

Porsche modelslook
familiar?

Some interesting Facts

The first real Porsche designed
in 1948

September 30, 1955:

James Dean is killed
driving his Porsche 550
Spyder

Porsche Today
Porsche is led by President and CEO Dr.
Wendelin Wiedeking (since 1993)

Net Sales (2003): E 5.582B

Net Income (2003): E 565M
EPS(2003): E 32.29
EPS Growth (2003): 22%
Porsche is essentially a privately held company. All 8.75M voting
shares are held by the Porsche family. The remaining 8.75M nonvoting shares are primarily held by institutional investors

The Jewel in the Porsche Crown has always been the 911 Series.
(14 different 911 models currently)

Engine: 3.6l 6 Cylinder Engine

Power: 325 Hp @ 6,800 RPM
Acceleration: 0-60 in 4.8 Sec.
Top Speed: 177 Mph

Porsche 911 Carrera

Units Sold (2003): 27,789

Average Price: E 92,000
Cost: E 78,000
Profit Margin: 16%

The 911 commands almost

exclusive ownership of its market
segment (high end sports cars).
While sales are cyclical, price
elasticity is very low.

The Boxster was introduced in 1996 to compete with the lowers

end sport scars already on the market.

Engine: 2.7l 6 Cylinder Engine

Power: 240 Hp @ 6,400 RPM
Acceleration: 0-60 in 5.9 Sec.
Top Speed: 160 Mph

Porsche Boxster

Units Sold (2003): 18,411

Average Price: E 44,000
Cost: E 41,000
Profit Margin: 8%

The Boxster is less cyclical than

the 911, but much more price
sensitive particularly since
introduction of the BMW Z4 in
2003

Porsche recently gained entry into the lucrative SUV market. Fuelled by
SUV crazy Americans, the launch of the Cayenne in 2002 has been
hailed as one of the most successful produce launches in history
Engine: 3.2l 6 Cylinder Engine
Power: 247 Hp @ 6,000 RPM
Acceleration: 0-60 in 8.5 Sec.
Top Speed: 133 Mph

Porsche Cayenne

Units Sold (2003): 20,603

Average Price: E 68,000
Cost: E 61,000
Profit Margin: 10%

The Cayenne is clearly at the high

end for SUVs Porsche is quickly
moving to develop a lower
powered, lower cost version.

Porsches Growing Sales

Porsches Competitive
Position
Automaker
Sales
Revenue Margin
Debt (%

ROIC

(Billions)

(Per
Vehicle)

of
Assets)

Audi

E 22.6

E 27,000

6.6%

.2%

NA

BMW

E 42.3

E 32,211

8.0%

47.5%

11.3%

Fiat

E 58.2

E 25,829

1.6%

31.3%

-2.9%

Mercedes

E 50.2

E 39,000

6.4%

NA

NA

Peugeot

E 54.4

E 16,192

5.3%

42.9%

10.5%

Porsche

E 5.6

E 72,889

16.4%

6.4%

20.5%

Renault

E 36.3

E 14,250

4.1%

47.6%

3.7%

Volkswagen

E 86.9

E 13,583

5.2%

42.4%

6.8%

We learned the hard way that banks are never there when you
need them : Porsches anti-debt philosophy

Porsches Foreign Exchange

ExposureUnited Kingdom
United States
Automaker

Sales

Production

Sales

Production

BMW

11%

15%

26%

11%

Fiat

6%

0%

0%

0%

Mercedes

9%

0%

19%

7%

Peugeot

12%

6%

0%

0%

Porsche

11%

0%

42%

0%

Renault

9%

0%

1%

1%

Volkswagen

7%

0%

13%

7%

Porsche has the heaviest US exposure (and this is increasing), yet it

has the lowest rate of natural hedging in the sector (Citigroup)

Pricing Pressures

Porsches Newest Model, the 911 Carrera 4s Cabriolet (2003)was

priced in continental Europe at E 85,000 (a 15% markup over cost of
$72,000). Simultaneously, the new Cabriolet was introduced in the
US for $93,000
Implied Exchange Rate =

$ 93,000
E 85,000

= 1.09 $/E (.91 E/$)

EUR/USD

As the Dollar falls, so do profit

margin!
At the current $1.29 per Euro exchange rate
$ 93,000
= E 72,093
1.29 $/E

A profit margin of essentially

zero over the cost of E 72,000!!

Alternatively, Porsche could price to 911 in the US at a lower profit

margin (say, that of the Boxster -8%)
E 72,000(1.08) = E 77,800(1.29) = $100,310

Price elasticity of the 911 is the lowest of the various Porsche

platforms, but could the US market withstand a price increase of this
magnitude? (7.8%)

Porsches Problem Defined:

Porsche has three model lines
with different market
characteristics 45% of
Porsches sales are in the US
($1.836B per year)

With the exception of an

assembly plant in Finland (also a
Euro country), all Porsches are
manufactured in Germany

As the dollar continues to decline, what options does Porsche

have to cover its currency exposure?

What did Porsche Actually

Do?
Porsche chose an aggressive strategy of put options on dollars
(i.e. contracts to sell dollars at a fixed price). Porsche maintains a
3 year rolling portfolio of put options with strike prices based on
currency forecasts. - Sales revenues through model year 2006 are
completely hedged.
Currency Exposure Covered by Derivative Instruments
BMW: 35%
Mercedes: 30%
Porsche: 100%
Volkswagen: 30%

Is this the best strategy?