Lufthansa - Hedging Alternatives
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.
Background
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 uncovered, use of forward contracts with either partial or full coverage, matching of currency with cash inflows of U.S. dollars, foreign currency options or buy and invest in U.S. dollars now.
Given the various hedging alternatives, Lufthansa could ideally choose any of these options, however due to strict company guidelines already set in place with regards to the type of financial hedging that could affect the company balance sheet, Ruhnau’s option were further limited.
Since the U.S. dollar had been on a steady rise since 1980, Ruhnau believed that the dollar would weaken, however he was not certain by how much and whether or not it would weaken enough
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.
Background
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 uncovered, use of forward contracts with either partial or full coverage, matching of currency with cash inflows of U.S. dollars, foreign currency options or buy and invest in U.S. dollars now.
Given the various hedging alternatives, Lufthansa could ideally choose any of these options, however due to strict company guidelines already set in place with regards to the type of financial hedging that could affect the company balance sheet, Ruhnau’s option were further limited.
Since the U.S. dollar had been on a steady rise since 1980, Ruhnau believed that the dollar would weaken, however he was not certain by how much and whether or not it would weaken enough