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Homework answers / question archive / FIN 4615 & 5615 - Derivatives Securities Hedging Currency Risks at AIFS (Case#: 205026) Please prepare a report to Sir Cyril Taylor (the founder) addressing the following issues and defend any assumptions you make
FIN 4615 & 5615 - Derivatives Securities
Hedging Currency Risks at AIFS (Case#: 205026)
Please prepare a report to Sir Cyril Taylor (the founder) addressing the following issues and defend any assumptions you make. Excel computations are needed. Please pay special attention to addressing your key conclusions in your memo and supporting them logically. Please make sure your work looks professional and is easy to read both on screen and when printed out.
1. Please explain the underlying economics of the AIFS business and identify the sources of the exchange rate exposure
a. How does AIFS make money?
b. What gives rise to the currency exposure at AIFS?
Hint: think about AIFS revenues and costs currencies; how do currency fluctuations influence AIFS? Why does AIFS bear the risk of currency fluctuations instead of just passing this risk onto its customers? What types of risk AIFS needs to manage? Etc.
2. Please analyze how various hedging strategies impact the business under different volume scenarios. What hedging strategy is the best for each scenario? You can address this question using the Excel template “Hedging Currency Risks at AIFS Template.” For each of the following scenarios, please consider three alternative strategies (no hedge,
100% hedge with forwards, and 100% hedge with options) and consider three exchange rate levels (stable dollar: 1.22 USD/EUR; strong dollar 1.01 USD/EUR; and weak dollar
1.48 USD/EUR).
a. Base Case Scenario: 25,000 customers (as forecast)
b. High Sales Volume Scenario: 30,000 customers
c. Low Sales Volume Scenario: 10,000 customers
Hint: The company forecasts its expected costs in dollars, using the current USD/EUR exchange rate, and these forecast costs provide a benchmark. If actual dollar costs are the same as forecast costs, there is “zero impact” on the company’s forecast cash flow. Actual dollar costs may be higher or lower than the benchmark costs because of fluctuations in the USD/EUR exchange. The impact of each hedging strategy is measured relative to the benchmark costs, or by comparing actual dollar costs using the hedge to the benchmark (“zero impact”) costs.
3. What hedging decision would you advocate?
a. What are the advantages and disadvantages of forward and option hedging strategies?
b. What scenario (base case, high volume, or low volume) should we design a hedging strategy for? (Hint: identify the outcomes you are most worried about when designing a hedging strategy.)
c. Any other considerations?
Structure and Content of Report:
1. Introduction
- The introduction sets the stage for the work to follow
- Please use one paragraph to describe the key issue(s) that your analysis addresses
2. Analysis
- The text of your analysis will constitute the bulk of the written presentation.
- Please explain the process you took to compute the required metrics and provide
clearly articulated responses to the questions posed.
- Please include in the appendices all supplementary figures, tables, and any other data necessary to support the analysis. Please be sure to reference information in appendices in the text of your report.
3. Conclusion
- Please use one paragraph to summarize the key results of the analysis and your recommendation.
4. Appendix
- All supplementary figures, tables, and any other data necessary to support the analysis
The text of your report should be about 2 to 3 pages. The page limit does not include appendices, which should be at the end of your written analysis.
