Jennifer Choi

1
Group 4

• Jennifer Choi
• Tommy Fermin
• Luz Pacheco
• Ibrahim Shaikh

2
Agenda

• Company Background - Tommy
• Case Details - Jennifer
• Defining the Issues - Luz
• Alternative Analysis - Ibrahim
• Recommendation - Tommy
• Q A

3
Company Background

• Deutsche Lufthansa AG (DLAKY.PK) - founded 1926
  in Berlin following merger of Deutsche Aero Lloyd
  and Junkers Luftverkehr
• Luft Air Hansa Company
• Symbol of flying and technical expertise
• 1927 first flights to China
• 1934 first trans-Atlantic flights
• 1945 to 1955 air traffic suspended due to war
• 1960 enters the jet aircraft age

4
Company Background (cont.)

• Sixth largest airline in the world (Second
  largest in Europe)
• Lufthansa Cargo AG is the leading cargo air
  carrier
• Divisions in aircraft maintenance, catering, IT,
  and leisure/travel businesses
• Approx. 23.6 billion 2006 Fiscal YE Revenue

5
Company Background (cont.)

• Operations in Europe, North/South America,
  Africa, Middle East, and Pac Rim regions (45
  million passengers/year)
• Main hubs in Frankfurt and Munich
• 437 aircraft fleet approx. 60 Airbus, 40
  Boeing
• Key Competitors Air France-KLM, AMR Corp, and
  British Airways

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Agenda

• Company Background - Tommy
• Case Details - Jennifer
• Defining the Issues - Luz
• Alternative Analysis - Ibrahim
• Recommendation - Tommy
• Q A
• 
  

7
Case Details Overview

• In January 1985, Lufthansa Chairman Herr Heinz
  Ruhnau purchased twenty Boeing 737 jets
• Total Price 500 million USD, payable January
  1986
• USD upward trend against the Deutschmark since
  1980
• 3.2 DM / 1
• Ruhnau believed the trend had reached a plateau
  and would soon decline
• Hedge to mitigate exchange rate risk / purchase
  cost

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Case Details X/C Rate Trend
DM3.2/ Jan-85
Sourced by www.oanda.com
9
Inflation Rate US 1980s

• Deregulation - know as Reagonomics
• Low corporate tax rates low inflation rates
• US Dollar appreciated from 1981-1985.

• PPP U.S low inflation rate made it a good place
  to invest

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Case Details - Decision Criteria

• Ruhnaus belief that the dollar would depreciate
  against the Deutschmark
• Tolerable level of risk using companys funds
• Limited capital on hand
• Balance sheet currency debt restrictions

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Case Details - Outcome

• 250 million forward contract _at_ 3.2 DM / 1 (250
  million uncovered)
• USD upward trend against the Deutschmark
  continued through February 1985 and then
  plummeted
• 2.3 DM / 1 spot rate in January 1986 (3.2 DM /
  1 January 1985)
• Total Cost of Boeing Deal

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Case Details X/C Rate Trend
Apr-85
DM2.9/ Jul-85
DM3.2/ Jan-85
Sourced www.oanda.com
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Case Details Outcome (cont.)

• February 1986, Ruhnau summoned to meet with
  Lufthansa board of directors over management of
  exchange rate exposure for the Boeing deal
• Criticized by the board for the use of forward
  contracts as exposure not for leaving half of
  the deal uncovered

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Agenda

• Company Background - Tommy
• Case Details - Jennifer
• Defining the Issues - Luz
• Alternative Analysis - Ibrahim
• Recommendation - Tommy
• Q A

15
Defining the Issues
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Defining the Issues Exchange Rate Risk

• Importance
• Increased cost of doing business
• Negative impact to bottom line
• Urgency
• Timing is critical
• Volatile movement

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Defining the Issues Hedging Methods

• Importance
• Need to control costs
• Mitigate exchange rate risk
• Urgency
• Method selection is critical
• Method needs to provide flexibility and tolerable
  level of risk

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Defining the Issues - Hedging Methods (cont.)

• Remain Uncovered maximum risk largest
  gain/loss possible
• Full Forward Cover minimum risk
• Partial Forward Cover medium risk uncovered
  exposure
• Foreign Currency Option low risk sunk cost
  (premium) fairly new tool
• Buy Dollars Now zero risk, cash availability,
  balance sheet currency debt restrictions

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Cause and Effect
ExchangeRate
Economy
People
Partial Forward Cover 3.2DM/ 250,000 2.2DM/
250,000
Risk level/Constraints
Hedging Method
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Agenda

• Company Background - Tommy
• Case Details - Jennifer
• Defining the Issues - Luz
• Alternative Analysis - Ibrahim
• Recommendation - Tommy
• Q A

21
Alternative Analysis
22
Net Cost by Hedging Alternatives
Remain Uncovered
Put Option Cover
Full Forward Cover
Billions of DM
Partial Forward Cover
Ending DM/ Exchange Rate (Jan 1986)
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Alternative Analysis
- 900 million variance too risky
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Alternative Analysis
- Negates risk legal obligation forego
favorable movements
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Alternative Analysis
- Legal obligation forego favorable movements
uncovered at risk
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Alternative Analysis
- Flexible cost ceiling premium
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Alternative Analysis
- Limited capital on hand forego favorable
movements
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Agenda

• Company Background - Tommy
• Case Details - Jennifer
• Defining the Issues - Luz
• Alternative Analysis - Ibrahim
• Recommendation - Tommy
• Q A

29
Recommendation

• CURRENCY OPTION
• Flexibility option to walk away
• Limited downside risk
• Maximum total cost is determinable whether
  exchange rate remains unchanged or increases
  (1,696,000,000 DM)
• Cost difference between a fully uncovered
  position at a decreasing exchange rate and option
  is the premium (96,000,000)

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Recommendation - Implementation

• Negate forward contract executed by Ruhnau
• Once exchange rate hit 3.3 DM/, execute sell
  forward contract
• Net money gain 25 million USD (10,869,565 DM _at_
  2.3 DM/)
• Purchase currency option for full 500 million
  USD exposure
• Reduce option premium cost to 85,130,435 DM

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Recommendation Alternative Solution

• Examine the alternative of purchasing planes from
  Airbus
• Airbus is a primary European competitor of Boeing
• Bidding war creates leverage for Lufthansa
• Highly subsidized by European countries lower
  operating costs lower price
• Common currency no exchange rate risk
• .

Airbus 320 which competes with Boeing 737
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THANK YOU
QUESTIONS?