Hedge or not to hedge

1. TO HEDGE OR NOT TO HEDGE
GROUP 1
Lufthansa

2. Case synopsis
In December 2012, Lufthansa,
placed order for ten 797-A model
from Boeing.
The agreed upon price was Euro
650 million(assumed value),
payable in US$ on delivery of
the aircrafts in one year, that is
on December 2013.

3. Case facts
Transaction value – 650 mn Euro(assumed)
Date of delivery and payment – 1 Dec 2013
Negotiation with Boeing to purchase 10 aircrafts
Purchase in Euro
Payment in USD

4. Our Expectations in Currency movement
Higher limit
1.5USD/EUR
Lower limit
1.00 USD/EUR

5. Hedging alternatives
Remain uncovered
Full forward cover
Option hedging
Money market hedging
Some combination of the above alternatives

6. Remain uncovered – maximum risk
Do noting
1.1 USD/Euro
Value
715millionUSD/EURO
1.5 USD/Euro
Value
975millionUSD/EURO
1.2 USD/EURO
Value
780millionUSD/EURO

7. Assumptions
Total Transaction value (mn Euro) 650mn Euro
Spot rate (1 DEC 2012 1.288USD/Euro
1 year forward rate 1.2949USD/Euro
Strike price for put option 1.29USD/Euro
%Premium on put option(on USD value 1%on USD value
Percentage cover 100% or 50%
1 year Interest rate(US) 1.05%
1 year Interest rate(Euro) 0.40%

8. Exchange rate Scenario 1
1.1 Euro /USD
Sl NO Strategy
Possible
Exchange
rate(1dec 2013)
Relaven
t rates
Upfront
costs
Total
cost(USD
Mn)
1Uncovered 1.1 1.10nill 715
2Full forward 1.1 1.29nill 842
350% forward 1.1 1.20nill 778
4Full option 1.1 1.29 8.42 850
550% option 1.1 1.20 7.78 723
6
Money market
Hedging 1.1 1.29 828.50 831.81

9. Exchange rate Scenario 2
1.5 Euro /USD
Sl NO Strategy
Possible Exchange
rate(1dec 2013
Relavent
rates
Upfront
costs
Total
cost(USD
Mn)
1Uncovered 1.5 1.50nill 975.00
2Full forward 1.5 1.29nill 841.69
350% forward 1.5 1.40nill 908.34
4Full option 1.5 1.29 8.4 850.10
550% option 1.5 1.40 9.1 917.43
6
Money market
Hedging 1.5 1.288 828.50 831.81

10. Exchange rate Scenario 3
1.2 Euro /USD
Sl NO Strategy
Possible
Exchange
rate(1dec 2013
Relavent
rates
Upfron
t costs
Total
cost(USD
Mn)
1Uncovered 1.2 1.00nill 780.00
2Full forward 1.2 1.29nill 841.69
350% forward 1.2 1.15nill 745.84
4Full option 1.2 1.29 8.42 850.10
550% option 1.2 1.15 7.46 753.30
6
Money market
Hedging 1.2 1.288 828.50 831.81

11. Money market Hedging
 Lufthansa buy 650mn/1.0105 Euro in the spot
market by borrowing USD at an interest rate of 0.4%
 Convert USD into Euro at spot rate of 1.288 on 1 dec
2012
 Invest Euro for one year at a rate of 1.05%
 Repay the USD loan on 1 dec 2013
 Make payment to Boeing on 1 dec 2013 by realizing
Euro 650mn from the investment

12. Summary of alternatives
Strategy Scenario 1 Scenario 2 Scenario 3
1.1 1.5 1.2
Total cost(USD Mn)
Uncovered 715.00 975.00 780.00
Full forward 841.69 841.69 841.69
50% forward 778.34 908.34 745.84
Full option 850.10 850.10 850.10
50% option 722.78 917.43 753.30
Money market
Hedging 831.81 831.81 831.81

13.  Thank you