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Hedging Currency Risks At Aifs Essay

723 words - 3 pages

AIFS’ business of sending students abroad and the timing difference between when the prices were set and when payment was received created transaction exposure. Guaranteeing that prices of the trips would not change prior to the release of the next catalog was a major table stake of the company’s business, and very important to maintaining a loyal customer base. Given this, movements in the cost basis caused by fluctuations in exchange rates could not be passed onto customers. When combined with the fact that there was a relatively long lead time between when prices were locked in and when the payment from students was received (over a year in the college student program) resulted in a ...view middle of the document...

When hedging with only options the company can limit adverse currency movements to the cost of the option contracts for a notional amount of $30.5mm in both the 1.22 and 1.48 USD/EUR scenarios. Furthermore, AIFS would be allowed to book gains upon exercising of the option contracts if the dollar strengthened versus the euro, less the cost of the contracts.

An analysis of AIFSs hedging strategy if sales volume are lower (10K) or higher (30K) than the expected sales volume (25K) reveals that whenever sales volumes are lower(Exhibit A) , the costs of using Forward contracts are higher in case spot exchange rates are less than the locked in forward price. This is because AIFS has to honor the forward contracts beyond the 10 K sales volume at a higher spot rate than the market. In such a scenario, Options are favorable despite the 5% premium outlay. Although, with low sales, option contracts provide fewer gains than forward contracts, considering the downside, options are still better in a low sales volume scenario. If spot rates end up being higher than the locked in rates at low volumes, AIFS can reduce their losses on...

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