1 group 4 jennifer choi tommy fermin luz pacheco ibrahim shaikh
Post on 21-Dec-2015
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1
Group 4
Jennifer ChoiTommy Fermin
Luz PachecoIbrahim Shaikh
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Agenda
Company Background - Tommy Case Details - Jennifer Defining the Issues - Luz Alternative Analysis - Ibrahim Recommendation - Tommy Q & A
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Company Background
Deutsche Lufthansa AG (DLAKY.PK) - founded 1926 in Berlin following merger of Deutsche Aero Lloyd and Junkers Luftverkehr
Luft – “Air” Hansa – “Company”
Symbol of flying and technical expertise
1927 – first flights to China1934 – first trans-Atlantic flights1945 to 1955 – air traffic suspended due to war1960 – enters the jet aircraft age
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Sixth largest airline in the world (Second largest in Europe)
Lufthansa Cargo AG is the leading cargo air carrier
Divisions in aircraft maintenance, catering, IT, and leisure/travel businesses
Approx. $23.6 billion 2006 Fiscal YE Revenue
Company Background (cont.)
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Company Background (cont.)
Operations in Europe, North/South America, Africa, Middle East, and Pac Rim regions (45 million passengers/year)
Main hubs in Frankfurt and Munich
437 aircraft fleet – approx. 60% Airbus, 40% Boeing
Key Competitors: Air France-KLM, AMR Corp, and British Airways
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Agenda
Company Background - Tommy Case Details - Jennifer Defining the Issues - Luz Alternative Analysis - Ibrahim Recommendation - Tommy Q & A
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Case Details: Overview In January 1985, Lufthansa Chairman Herr Heinz Ruhnau
purchased twenty Boeing 737 jets
Total Price = $500 million USD, payable January 1986
USD upward trend against the Deutschmark since 1980 3.2 DM / $1
Ruhnau believed the trend had reached a plateau and would soon decline
Hedge to mitigate exchange rate risk / purchase cost
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Case Details: X/C Rate Trend
DM3.2/$DM3.2/$Jan-85Jan-85
Sourced by www.oanda.com
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Inflation Rate US 1980’s
PPP – U.S low inflation rate made it a good place to invest
Deregulation - know as “Reagonomics” Low corporate tax rates & low inflation rates US Dollar appreciated from 1981-1985.
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Case Details - Decision Criteria Ruhnau’s belief that the dollar would depreciate against the
Deutschmark
Tolerable level of risk using company’s funds
Limited capital on hand
Balance sheet currency debt restrictions
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Case Details - Outcome $250 million forward contract @ 3.2 DM / $1 ($250 million
uncovered)
USD upward trend against the Deutschmark continued through February 1985 and then plummeted
2.3 DM / $1 spot rate in January 1986 (3.2 DM / $1 January 1985)
Total Cost of Boeing Deal
USD DM1985 Forward Contract (3.2 DM/$) 250,000,000 800,000,000 1986 Spot Rate ( 2.3 DM/$) 250,000,000 575,000,000
Total Cost 1,375,000,000
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Case Details: X/C Rate Trend
0
0.5
1
1.5
2
2.5
3
3.5
DM/$
DM3.2/$DM3.2/$Jan-85Jan-85
Apr-85
Sourced www.oanda.com
DM2.9/$Jul-85
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Case Details – Outcome (cont.) February 1986, Ruhnau summoned to meet with
Lufthansa board of directors over management of exchange rate exposure for the Boeing deal
Criticized by the board for the use of forward contracts as exposure; not for leaving half of the deal uncovered
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Agenda
Company Background - Tommy Case Details - Jennifer Defining the Issues - Luz Alternative Analysis - Ibrahim Recommendation - Tommy Q & A
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Defining the Issues
Importance
Urgency
Low High
Low Forecast Exchange Rate
Financial Health of Company/Shareholders
High Type of Planes IV
Exchange Rate Risk
Hedging Method
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Defining the Issues – Exchange Rate Risk
Importance: Increased cost of doing business
Negative impact to bottom line
Urgency: Timing is critical
Volatile movement
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Defining the Issues – Hedging Methods
Importance: Need to control costs
Mitigate exchange rate risk
Urgency: Method selection is critical
Method needs to provide flexibility and tolerable level of risk
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Defining the Issues - Hedging Methods (cont.)
Remain Uncovered – maximum risk; largest gain/loss possible
Full Forward Cover – minimum risk
Partial Forward Cover – medium risk; uncovered exposure
Foreign Currency Option – low risk; sunk cost (premium); fairly new tool
Buy Dollars Now – zero risk, cash availability, balance sheet currency debt restrictions
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Cause and Effect
Risk level/Constraints
Partial Forward Cover:
3.2DM/$ $250,000
2.2DM/$ $250,000
Economy People
Hedging Method
ExchangeRate
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Agenda
Company Background - Tommy Case Details - Jennifer Defining the Issues - Luz Alternative Analysis - Ibrahim Recommendation - Tommy Q & A
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Alternative AnalysisALTERNATIVE
Scenario Total Cost Risk1) Remain Uncovered A $500 million @ 2.2 DM 1,100,000,000 HIGH
B $500 million @ 4.0 DM 2,000,000,000
2) Full Forward Cover A $500 million @ 3.2 DM 1,600,000,000 LOW
3) Partial Forward Cover A $250 million @ 3.2$250 million @ 2.2 1,350,000,000 MEDIUM
B $250 million @ 3.2$250 million @ 4.0 1,800,000,000
4) Foreign Currency Option/Put Option A $500 million @ 3.2 + 6% premium 1,696,000,000 LOWB $500 million @ 2.2 + 6% premium 1,196,000,000 C $500 million @ 4.0 + 6% premium 1,696,000,000
5) Buy Dollars Now/ Money Market A $500 million @ 3.2 1,600,000,000 N/A
DECISION CRITERIA
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Net Cost by Hedging Alternatives
1.00
1.20
1.40
1.60
1.80
2.00
2.20
2.20 2.40 2.60 2.80 3.00 3.20 3.40 3.60 3.80 4.00
Remain Uncovered
Full Forward CoverPut Option Cover
Partial Forward Cover
Billions of D
M
Ending DM/$ Exchange Rate (Jan 1986)
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Alternative AnalysisALTERNATIVE
Scenario Total Cost Risk1) Remain Uncovered A $500 million @ 2.2 DM 1,100,000,000 HIGH
B $500 million @ 4.0 DM 2,000,000,000
2) Full Forward Cover A $500 million @ 3.2 DM 1,600,000,000 LOW
3) Partial Forward Cover A $250 million @ 3.2$250 million @ 2.2 1,350,000,000 MEDIUM
B $250 million @ 3.2$250 million @ 4.0 1,800,000,000
4) Foreign Currency Option/Put Option A $500 million @ 3.2 + 6% premium 1,696,000,000 LOWB $500 million @ 2.2 + 6% premium 1,196,000,000 C $500 million @ 4.0 + 6% premium 1,696,000,000
5) Buy Dollars Now/ Money Market A $500 million @ 3.2 1,600,000,000 N/A
DECISION CRITERIA
- 900 million variance; too risky
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Alternative AnalysisALTERNATIVE
Scenario Total Cost Risk1) Remain Uncovered A $500 million @ 2.2 DM 1,100,000,000 HIGH
B $500 million @ 4.0 DM 2,000,000,000
2) Full Forward Cover A $500 million @ 3.2 DM 1,600,000,000 LOW
3) Partial Forward Cover A $250 million @ 3.2$250 million @ 2.2 1,350,000,000 MEDIUM
B $250 million @ 3.2$250 million @ 4.0 1,800,000,000
4) Foreign Currency Option/Put Option A $500 million @ 3.2 + 6% premium 1,696,000,000 LOWB $500 million @ 2.2 + 6% premium 1,196,000,000 C $500 million @ 4.0 + 6% premium 1,696,000,000
5) Buy Dollars Now/ Money Market A $500 million @ 3.2 1,600,000,000 N/A
DECISION CRITERIA
- Negates risk; legal obligation; forego favorable movements
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Alternative AnalysisALTERNATIVE
Scenario Total Cost Risk1) Remain Uncovered A $500 million @ 2.2 DM 1,100,000,000 HIGH
B $500 million @ 4.0 DM 2,000,000,000
2) Full Forward Cover A $500 million @ 3.2 DM 1,600,000,000 LOW
3) Partial Forward Cover A $250 million @ 3.2$250 million @ 2.2 1,350,000,000 MEDIUM
B $250 million @ 3.2$250 million @ 4.0 1,800,000,000
4) Foreign Currency Option/Put Option A $500 million @ 3.2 + 6% premium 1,696,000,000 LOWB $500 million @ 2.2 + 6% premium 1,196,000,000 C $500 million @ 4.0 + 6% premium 1,696,000,000
5) Buy Dollars Now/ Money Market A $500 million @ 3.2 1,600,000,000 N/A
DECISION CRITERIA
- Legal obligation; forego favorable movements; uncovered at risk
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Alternative Analysis ALTERNATIVE
Scenario Total Cost Risk1) Remain Uncovered A $500 million @ 2.2 DM 1,100,000,000 HIGH
B $500 million @ 4.0 DM 2,000,000,000
2) Full Forward Cover A $500 million @ 3.2 DM 1,600,000,000 LOW
3) Partial Forward Cover A $250 million @ 3.2$250 million @ 2.2 1,350,000,000 MEDIUM
B $250 million @ 3.2$250 million @ 4.0 1,800,000,000
4) Foreign Currency Option/Put Option A $500 million @ 3.2 + 6% premium 1,696,000,000 LOWB $500 million @ 2.2 + 6% premium 1,196,000,000 C $500 million @ 4.0 + 6% premium 1,696,000,000
5) Buy Dollars Now/ Money Market A $500 million @ 3.2 1,600,000,000 N/A
DECISION CRITERIA
- Flexible; cost ceiling; premium
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Alternative AnalysisALTERNATIVE
Scenario Total Cost Risk1) Remain Uncovered A $500 million @ 2.2 DM 1,100,000,000 HIGH
B $500 million @ 4.0 DM 2,000,000,000
2) Full Forward Cover A $500 million @ 3.2 DM 1,600,000,000 LOW
3) Partial Forward Cover A $250 million @ 3.2$250 million @ 2.2 1,350,000,000 MEDIUM
B $250 million @ 3.2$250 million @ 4.0 1,800,000,000
4) Foreign Currency Option/Put Option A $500 million @ 3.2 + 6% premium 1,696,000,000 LOWB $500 million @ 2.2 + 6% premium 1,196,000,000 C $500 million @ 4.0 + 6% premium 1,696,000,000
5) Buy Dollars Now/ Money Market A $500 million @ 3.2 1,600,000,000 N/A
DECISION CRITERIA
- Limited capital on hand; forego favorable movements
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Agenda
Company Background - Tommy Case Details - Jennifer Defining the Issues - Luz Alternative Analysis - Ibrahim Recommendation - Tommy Q & A
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Recommendation CURRENCY OPTION
Flexibility – “option to walk away”
Limited downside risk
Maximum total cost is determinable whether exchange rate remains unchanged or increases (1,696,000,000 DM)
Cost difference between a fully uncovered position at a decreasing exchange rate and option is the premium (96,000,000)
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Recommendation - Implementation Negate forward contract executed by Ruhnau
Once exchange rate hit 3.3 DM/$, execute sell forward contract
Net money gain $25 million USD (10,869,565 DM @ 2.3 DM/$)
Purchase currency option for full $500 million USD exposure Reduce option premium cost to 85,130,435 DM
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Recommendation – Alternative Solution
Examine the alternative of purchasing planes from Airbus Airbus is a primary European competitor of Boeing
Bidding war creates leverage for Lufthansa
Highly subsidized by European countries; lower operating costs = lower price
Common currency; no exchange rate risk.
Airbus 320 which competes with Boeing 737
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QUESTIONS?
THANK YOU