Lufthansa 8
LUFTHANSA CASE ANALYSIS
Executive Summary
Lufthansa CEO Herr Ruhnau was under-fired for his hedging decision on the purchase of 20 Boeing aircrafts which cost Lufthansa an additional DM 225M back in Jan. 1985. Some criticisms are valid to a certain degree given the strict covenants and guidelines Ruhnau had to work against however others are base-less such as forcing Ruhnau to step down as CEO. This case analysis will discuss the hedging alternatives Ruhnau considered, the decision that was made, an analysis of the criticisms made against Ruhnau and justifications for why Ruhnau should continue his chairmanship of Lufthansa. By using a partial forward cover, Herr Heinz acted to mitigate risk from further DM depreciation while also taking advantage of DM appreciation should it occur as he expected. The DM did appreciate from 3.2DM/$ to 2.3DM/$. The total cost to Lufthansa dropped from DM1.6 billion to DM1.375M, a savings of DM225 million, by using the partial forward cover. However given the significant volatility in DM/$ rate, the put option method would have saved an additional DM129 million for a total savings of DM354 million. Had DM appreciated less than 12%, the partial forward cover would have saved Lufthansa more money than put option.
Detailed Analysis
In January 1985, German-based airline Lufthansa, under the direction of chairman Herr Heinz Ruhnau, purchased twenty Boeing 737 jets at a hefty price of $25,000,000 per for a total transaction of $500,000,000. The term of the purchase is for Lufthansa to pay the entire amount in U.S. dollars upon delivery one year later in January 1986. As of Jan. 1985, the conversion rate stood at DM 3.2/$ and with the U.S. dollar on a rise against the German DM since 1980, Ruhnau had several financial hedging options to undertake in order to minimize Lufthansa’s foreign exchange exposure risk for the next 12 months. These financial instruments include the basic hedging alternatives such as remaining
Executive Summary
Lufthansa CEO Herr Ruhnau was under-fired for his hedging decision on the purchase of 20 Boeing aircrafts which cost Lufthansa an additional DM 225M back in Jan. 1985. Some criticisms are valid to a certain degree given the strict covenants and guidelines Ruhnau had to work against however others are base-less such as forcing Ruhnau to step down as CEO. This case analysis will discuss the hedging alternatives Ruhnau considered, the decision that was made, an analysis of the criticisms made against Ruhnau and justifications for why Ruhnau should continue his chairmanship of Lufthansa. By using a partial forward cover, Herr Heinz acted to mitigate risk from further DM depreciation while also taking advantage of DM appreciation should it occur as he expected. The DM did appreciate from 3.2DM/$ to 2.3DM/$. The total cost to Lufthansa dropped from DM1.6 billion to DM1.375M, a savings of DM225 million, by using the partial forward cover. However given the significant volatility in DM/$ rate, the put option method would have saved an additional DM129 million for a total savings of DM354 million. Had DM appreciated less than 12%, the partial forward cover would have saved Lufthansa more money than put option.
Detailed Analysis
In January 1985, German-based airline Lufthansa, under the direction of chairman Herr Heinz Ruhnau, purchased twenty Boeing 737 jets at a hefty price of $25,000,000 per for a total transaction of $500,000,000. The term of the purchase is for Lufthansa to pay the entire amount in U.S. dollars upon delivery one year later in January 1986. As of Jan. 1985, the conversion rate stood at DM 3.2/$ and with the U.S. dollar on a rise against the German DM since 1980, Ruhnau had several financial hedging options to undertake in order to minimize Lufthansa’s foreign exchange exposure risk for the next 12 months. These financial instruments include the basic hedging alternatives such as remaining
References: http://www.federalreserve.gov/releases/h10/hist/dat89_ge.htm http://www.federalreserve.gov/releases/h15/data.htm http://www.bundesbank.de/statistik/statistik_zinsen.en.php