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Hedging Currency Risks at AIFS

FIN 659-01: Case Study Project

Zachary Connolly

on 11 May 2015

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Transcript of Hedging Currency Risks at AIFS

Hedging Currency Risks at AIFS
How does AIFS make money?
What gives rise to currency risk at AIFS? What are the risks they face?
What would happen with 100% hedge with forwards? With futures? Use the forecast final sales volume of 25000 and analyze the possible outcomes relative to the zero impact scenario?
What happens if sales volumes are lower or higher than expected as outlined at the end of the case?
What would happen if Archer-Lock and Tabaczynski did not hedge?
Presentation Breakdown
Executive Summary
Case Questions/Analysis
Works Cited

Desai, Mihir A., Vincent Dessain and Anders Sjoman. Hedging Currency Risks at AIFS. Case Study. Boston, MA: Harvard Business School, February 28, 2007. Online. 2015.



AIFS uses two different pricing decisions for the College and High School Travel divisions
Both programs take into account their cost base, competitive pricing and the hedging activities
The College division worked from July 1 to June 30, or the academic planning year.
June 30 of the previous year was the deadline for setting prices for any given year.
Throughout the year Archer-Lock met regularly with marketing and operations managers to discuss sales forecasts and events that might affect sales.
The managers also put out weekly sales forecasts, which Archer-Lock could use to base his hedging activities.
The ACIS catalog contained about 35,000 prices combining tours, seasons and departure gateways.
Set by Tabaczynski on a calendar year basis, January to December.
The strategy Tabaczynski wanted ACIS to follow was a slow, but steady price increases year by year.
This strategy was implemented to avoid sudden price hikes and even if ACIS was $200 more than their competitors over time their customers didn’t seem to care.
ACIS’s customer were very loyal: over 70% of the teachers were returning customers
Zachary Connolly, Pai Gao, David Hall, Dana Weinberg, Huan Xu, and Huan Zhang
FIN 659-01:
Professor Gopala Vasudevan

Executive Summary
: Should AIFS hedge? What hedging decisions would you advocate?

100% Options = Best hedging decision for AIFS
"Right vs Obligation"
American Institute for Foreign Studies (AIFS) founded in the U.S. in 1964 by Sir Cyril Taylor (HBS MBA 1961) [Pictured right]
Sent more than 50,000 students each year on academic and cultural exchange programs worldwide
Currency mismatches:
Revenues in USD ($200 million annually)
Costs in other currencies (EUR and GBP)
Two main divisions:
Study Abroad College division
High School Travel division
Founded in 1978 as the American Council for International Studies (ACIS)
Other divisions:
Au Pair division
Camp America division
Academic Year in America (AYA)
"Catalog-based" business
No "price surprises"
What is the “nightmare scenario” for AIFS?
There are three types of risks:
Bottom-line risk
: an adverse change in exchange rates could increase the cost base.
Volume risk
: Foreign currency was bought based on projected sales volumes, which would differ from final sales volumes.
Competitive pricing risk
: The AIFS price guarantee meant it could not transfer rate changes into price increases.
The competitive risk is closely link to the other risks, especially the bottom-line risk.
Beyond those three risks
AIFS also faced the risk of the
“low margin/high volume”
operations of the ACIS division
The ACIS division’s sales margins were highly susceptible to world events, such as the 1986 terrorism acts, the 1991 Gulf War, the 2001 September 11 attacks and the 2003 Iraq war.
Sales would drop as high as 60% for the ACIS division based on this news.
If the dollar is strong (1.01 USD/EUR) then there is a total cost savings of $5.25 million equating to $210 per participant.
If the dollar is weak (1.48 USD/EUR), however, there is a total cost negative windfall of $6.5 million equating to $260 per participant.
If AIFS chooses a no hedge strategy they face strong bottom-line risk.
Forwards vs. Options
1yr Forward Rate= $1.2258/Euro
Option Premium= 5% at $1.22/Euro Strike
25,000 students at a cost of 1000 Euros each
Cost of 100% Forward Contract= 25,000*1000*1.2258= $30,645,000
Cost of 100% Option Premium= 25,000*1000*1.22*.05= $1525000
100% Forward Scenarios
Strong Dollar @1.01 in One Year…
No Hedge Cost= $25,250,000
100% Hedge Cost= $30,645,000
Windfall= $30,645,000-$25,250,000
=Loss of $5,395,000

AIFS must pay 21.37% more in Costs.

100% Forward Scenarios
Steady Dollar @1.22 in One Year…
No Hedge Cost= $30,500,000
100% Hedge Cost= $30,645,000
Windfall= $30,645,000-$30,500,000
=Loss of $145,000
AIFS must pay .4754% more in costs
Equal to Forward Rate of (1.258-1.22)/1.22
100% Forward Scenarios
Weak Dollar @1.48 in One Year…
No Hedge Costs= $37,000,000
100% Hedge Costs= $30,645,000
Windfall= $30,645,000-$37,000,000
=Gain of $6,355,000

AIFS saves 17.18% in costs
100% Options Scenarios
Strong Dollar @1.01 in One Year…
No Hedge Cost= $25,250,000
ACIS will not Exercise Options…
Total Cost plus $1,525,000 premium
Windfall= Loss of $1,525,000
AIFS must pay 5.7% more in costs
100% Options Scenarios
Steady Dollar @1.22 in One Year…
No Hedge Cost= $30,500,000
ACIS will not Exercise Options…
Total Cost plus $1,525,000 premium
Windfall= Loss of $1,525,000
AIFS must pay 5% more= Options Premium
100% Options Scenarios
Weak Dollar @1.48 in One Year…
No Hedge Costs= $37,000,000
ACIS will Exercise Options…
Total Cost = 1.22*25,000,000+1,525,000
Windfall= Gain of $4,975,000
AIFS saves 13.45% in costs
Additional Hedging Scenarios
Weak Sales Scenario
Sales Volume= 10,000 students
Futures Cost= $30,645,000 for 25,000,000 Euro
AIFS is forced to sell 15,000,000 Euro back at current spot rate.
Total Loss in USD is the same but Windfall is accentuated…
Pay up to 53.42% more in costs
Sales Volume: 10,000
Strong USD: 1.01 EUR/USD
Sales Volume: 10,000
Weak USD: 1.48 EUR/USD
Save up to 42.94% in costs
Strong Sales Scenario
Sales Volume of 30,000 students
AIFS must pay for 5,000 students at spot rate.
Total Loss is the same, but windfall is minimized…
Sales volume: 30,000
Strong USD: 1.01 EUR/USD

Pay up to only 17.79% more in costs.
Sales volume: 30,000
Strong USD: 1.48 EUR/USD

Save up to only 14.31% in costs.
Low and High Volume with Options
AIFS is stuck paying the Premium of $1,525,000.
The Dollar amount gained and lost is the same as the expected volume…
Windfall percent is accentuated for low sales and minimized for high sales.
Contracts & Options
Did Not Hedge
1.22 EUR/USD
Call Option Loss
Forward Contracts
Call Options
Option Premium
Option Premium
Futures Loss
1.01 EUR/USD
1.48 EUR/USD
Mix of Options and Forwards
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