Lufthansa purchased $500 million worth of Boeing jets in 1985 payable in 1986. The head of treasury, Herr Ruhnau, was concerned about exchange rate risk as the dollar had been rising against the Deutschemark. He decided to hedge half the payment using forwards at the current exchange rate of DM3.2/$ and leave half unhedged. When payments were due in 1986, the dollar had weakened to DM2.3/$, exposing Lufthansa to a loss. Ruhnau was called before the board to explain his decision, though he argued the purchase was mandated and a mixed hedging approach reduced risk and cost compared to full hedging. The board ultimately did not

1. TRANSACTION EXPOSURE RISK
~CASE STUDY~
PRESENTED BY –
ISHA JOSHI
(BBA-FT IV SEM)

2. THE CASE
 In Jan 1985
 Lufthansa, purchased twenty 737 jets from Boeing.
 Total cost = $500 million
 Payable in US$
 Payments due in January 1986 upon delivery.

3. WHY NOW (JAN 1985)?
 Facts
US Dollar was rising steadily and rapidly against DM since
1980
In Jan 1985 spot rate was approximately DM3.2/$
 Lufthansa’s decision based on:
Purchase of operating assets must be based on
current/expected market conditions
Delay may adversely affect its operations
Price could be increased to offset decline in the dollar, If
purchased when the dollar was weakening
 Foreign currency will fluctuate based on the host country’s
economic and political conditions and policy changes

4. FOREIGN CURRENCY
EXPOSURE
 Definition
Impact of unexpected exchange rate changes upon the cash flows from
existing (and typically short-term) contractual obligations
 Measure Exposure
Use best measurement techniques
Calculate expected future exchange rates
 Manage Exposure
Consider all available methods to mitigate exposure
 Countertrade
 Hedging
 Simulate all methods (alternatives)

5. CONCERNS
 Herr Ruhnau was concerned over the exchange rate exposure
Lufthansa was bearing in this transaction
 The U.S. dollar had been steadily appreciating in value against
the Deutschemark since 1980
 Ruhnau, as many currency analysts, believed that dollar was
overvalued, it is expected to be depreciated soon
 Regardless, Herr Ruhnau felt this was too large a transaction to
be left unhedged

6. CONSTRAINTS
 Debt Covenant
 Payment due date
 Limited US Dollars available
 US Dollar appreciating
 The cost of hedging

7. OPPORTUNITIES
 Management is in support of the expansion strategy
 New hedging instrument: Options
 Herr’s expectation that the US Dollar will depreciate.
This is validated by IFE and PPP.

8. DECISION CRITERIA
Choose the hedging alternative that is the lowest
mix of the following:
 Cost: What is the cost based on our worst case
calculation
 Risk: How much exposure risk remains by
implementing this alternative

9. ALTERNATIVES
 Remain uncovered
 100% forward cover
 50% forward cover – 50% uncovered
 100% Option cover
 100% Option Straddle

10. THE DECISION & OUTCOME
 Ruhnau covered forward $250 million at DM 3.2/$,
and left the remaining $250 million uncovered.
 The dollar weakened from DM 3.2/$ to DM 2.3/$.
 Ruhnau was summoned to meet with Lufthansa’s
Board and West German Transportation Ministry
on February 14, 1986 to explain his speculative
exposure management decision on this transaction

11. THE INVISIBLES

12. THE ACCUSATIONS
 Purchasing the Boeing aircrafts at the wrong time.
 Choosing to hedge half of the exposure when he
expected the dollar to fall.
 Choosing forward hedging over options
 Purchasing Boeing jets at all

13. THE RATIONALE
 Purchase of Boeing aircrafts was mandated according to the
expansion program
 Ruhnau took a middle ground approach by half covered and
half uncovered, looks better in this case, but risky
 He considered the upfront cost of option premium (6% -
DM96m) is expensive and the tool was relatively new to market
and complicated
 To comply Lufthansa’s policy for a mix of Boeing and Airbus
aircrafts

14. THE CONCLUSION
 Hedging should be considered as a corporate strategy
 Single transaction like this one can jeopardous the company’s existence
or long time to recover, if the market moves to opposite direction
 Prestigious company like Lufthansa shouldn’t have left any exposure (big
or small) uncovered
 If all predictions towards no exchange rate movement or further US$
appreciation, use full cover futures
 If all predictions towards US$ depreciation, use full cover options

15. THE CONCLUSION (CONTD.)
 Ruhnau should be retained or fired?
The Board should choose DM 1.6b (DM3.2/$) as benchmark
With this benchmark, there are no damage caused to Lufthansa by
his decision
The 1985 decision must have been taken in accordance with the
Board. In that case, Ruhnau has only partial responsibility
So, Ruhanau shouldn’t be fired

16. THANK
YOU