Case 1: Hedging Currency Risks at AIFS
Instructions:
Please download the case and accompanying material from the HBS link that I provided on Canvas. For your analysis of the case, I am asking you put yourself in the shoes of the protagonist and help them solve the issues at hand with the expertise that you have acquired so far in class.
Your report should address the questions provided below and any other points you believe to be important for the analysis. Your report should be handed in at the beginning of the class the day the case is discussed. Supporting computations and tables can be included in an appendix.
Your case grade will be based on the analysis conducted, the conclusions reached, and how effectively those conclusions are communicated.
Mandatory
1. What gives rise to the currency exposure at AIFS? What are the two random variables that Archer-Lock and Tabaczynski have to deal with?
2. What would happen under the three exchange rate scenarios if Archer-Lock and Tabaczynski did not hedge at all? Use the forecast sales
volume of 25,000.
3. Repeat your analysis in question (2) with (a) a 100% hedge with forwards and (b) a 100% hedge with options. Again, use the forecast sales volume of 25,000.
Analyze the outcomes relative to the "zero impact" scenario described in the case (where rate = USD 1.22/EUR). For simplicity, please assume that the forward rate is 1.22, the option's strike price is also 1.22, and the option premium per EUR is 5% of the strike 1.22.
4. Fill completely the table in Exhibit 9. Analyze different levels of hedge coverage and different mixes of forwards and options. Which strategy would you prefer? Explain briefly.
5. Repeat your analysis in questions (2) to (4) under the high-volume and low-volume scenarios outlined at the end of the case. Note that hedge coverage is based on the forecast sales volume of 25,000 but the actual realized volume differs from the forecast. Which strategy would you prefer under each volume scenario? Why?
6. Considering all possibilities, what hedging decision would you advocate? Briefly discuss your criteria.
7. You expect that American students are more (less) likely to study abroad if USD is strong (weak). Of course, you do not know whether USD will be strong or weak against EUR in the future but you know that if USD is strong (weak), the sales volume is likely to be high (low). Under this assumption, how would you change your answer to question (6)?
8. You believe that AIFS' competitors do not hedge currency risk (and as a result set their prices based on the USD/EUR exchange rate at the time of sale). And, since students are price-sensitive, AIFS' sales volume is likely to be high (low) if its prices are better (worse) than the competition. Under this assumption, how would you change your answer to question (6)?