Hedging Currency at AIFS
Homework: Foreign Currency Transactions and Hedging - Hedging Currency Risk at AIFS Case
1. What gives rise to the currency exposure at AIFS.
Currency exposure or currency risk is the type of risk that an individual or a company faces due to the fluctuation in price of one currency against another. For AIFS –a student exchange organization that offers education and travel programs all over the world- the fact that they do business domestically and internationally gives rise to several factors that exposes them to currency risk. The first, and perhaps most important factor is the fact that AIFS receives most of their revenues in US Dollar ($) but incurs costs in other currencies, primarily in Euro (€) or British Pound (£). This situation forces AIFS to manage liquid assets in different currencies which exposes them to the “bottom-line risk or the risk that an adverse change in exchange rates could increase the cost base.” In order to protect and manage this risk AIFS utilizes hedging contracts in the form of forward and option contracts, which are purchased at a minimum of 6 month prior price setting date for the current catalogue.
Their business operations give way to another factor that accentuates their currency exposure. Because their hedging contracts start at least 6 months prior to the “main pricing date”, their sales volume and expense cover levels forecasted determines the type and the percentage of the hedging policy they implement. This is basically a “volume risk” because when they purchase currency based on a forecasted sales volume, there is a possibility that final sales would differ from those projected sales and the company would have to either purchase more currency at spot rates or perhaps incur in losses due to existing forwards contracts. Either of those two outcomes could erode AIFS’s profits.
One last factor that exposes AIFS to currency risk is their “Price Guaranteed Policy”. This policy states that regardless of how the currencies
1. What gives rise to the currency exposure at AIFS.
Currency exposure or currency risk is the type of risk that an individual or a company faces due to the fluctuation in price of one currency against another. For AIFS –a student exchange organization that offers education and travel programs all over the world- the fact that they do business domestically and internationally gives rise to several factors that exposes them to currency risk. The first, and perhaps most important factor is the fact that AIFS receives most of their revenues in US Dollar ($) but incurs costs in other currencies, primarily in Euro (€) or British Pound (£). This situation forces AIFS to manage liquid assets in different currencies which exposes them to the “bottom-line risk or the risk that an adverse change in exchange rates could increase the cost base.” In order to protect and manage this risk AIFS utilizes hedging contracts in the form of forward and option contracts, which are purchased at a minimum of 6 month prior price setting date for the current catalogue.
Their business operations give way to another factor that accentuates their currency exposure. Because their hedging contracts start at least 6 months prior to the “main pricing date”, their sales volume and expense cover levels forecasted determines the type and the percentage of the hedging policy they implement. This is basically a “volume risk” because when they purchase currency based on a forecasted sales volume, there is a possibility that final sales would differ from those projected sales and the company would have to either purchase more currency at spot rates or perhaps incur in losses due to existing forwards contracts. Either of those two outcomes could erode AIFS’s profits.
One last factor that exposes AIFS to currency risk is their “Price Guaranteed Policy”. This policy states that regardless of how the currencies