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annisa swavira

on 24 November 2015

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In early May 2008, Jean- Baptiste Pons, Head of Corporate Finance and Treasury at European Aeronautic Defense and Space Company N.V (EADS), a global aerospace and defense company, was preparing for the next week's meeting with the company's senior executives.

Over the last 3 years, Airbus EADS 's commercial jet division and its primary source of revenue, had reported record order intakes, exceeding the company's turnover at that time by 3 factors:
Since 2006, the U.S. Dollar ($) had depreciated substantially against the euro (€)
Airbus billed customers in dollars, while the costs and reported its financial statements in euros
EADS hedged future revenues with FX forward contract
EADS considered to choose FX options to hedge its foreign exchange exposures
EADS was establish
Dual Headquarters located in Paris - France and Munich - Germany
Grown its workforce:
Employ 116,500 people in 19 countries
Increased its annual revenues from €24.2 billion to €39.1 billion
Booked €550 billion of orders, which more then doubled its order backlog to €339.5 billion
Had become a major global player and generated more than half of its revenues and sealed around two-thirds of its orders outside Europe
Generated €25.2 billion in revenues of airbus as a core business

Airbus’ order book of 3,540 aircraft represented roughly 83% of the group’s €351.4 billion backlog at list prices

(€ billions except percentages) 2007
Exhibit 2
Exhibit 3
(€ millions) 2007
The Aerospace Industry
Airbus' and Boeing's Commercial Aircraft Deliveries, Number of Aircraft 1985 - 2007
Airbus' management attributed their long term catch up with Boeing to many factors:
launching new aircraft more frequently than their rival
catering to airlines' growing need for lower operating costs by cutting their jets' fuel consumption
using common cockpit elements across all aircraft families to decrease air carriers' training costs
tapping the low cost airline segment and luring air carrier from emerging market
2007, Boeing and Airbus 50% airliner market share
2007, the airliner market stood at 894 jet deliveries and seat a new record of 2754 orders
2008, The Dollar had remained the currency of commercial aircraft transaction
Becoming the worldwide leader in air and space platforms and systems
Targeting a 10% EBIT margin by 2015
Reaching €80 billion in turnover by 2020, half of which would come from Airbus
Lifting non-European sourcing from 23% to 40% by 2020
Financial Performance
(€ millions, except per share amounts)
Airbus' ability to compete against US based manufacturers in the US dollar priced aircraft market was affected by the euro's and the pound's exchange rate to the dollar
Airbus' dollar revenues converted to euros declined
Has significant impact of FX risk on EADS' financial results
Every 10-cent movement in the dollar to euro exchange rate against is a € billion impact at EADS
Measuring Airbus 's FX Exposures
FX Risk Management Strategy
The group management pursued a double-pronged approach to FX Risk management :
1. Risk mitigation achieved through operating decision (natural hedges)
The risk mitigation objective is to minimize their expected net dollar inflows.
It was estimated that without natural hedges, EADS’ hedge able exposure would have been twice as high.
FX want to achieving a better match between dollar revenues and dollar costs.

2. Risk transfer achieved through the selective use of FX derivative contracts:
With portfolio of derivatives, mainly FX forward contracts, EADS’ locked in exchange rates at which its future dollar receivables could be converted into euros.
The overall aim of hedging using derivatives was to protect the firm’s EBIT against the dollar’s decline and to meet shareholder expectations of stable future euro-denominated earnings
Derivative hedging is a way of buying time for the adaption of the cost structure.

EADS’S General policy for managing foreign exchange risk was to cover up to 100% of eligible exposure for aircraft deliveries within the next three years, and then steadily decrease the proportion of total eligible exposure that is covered for the subsequent five years.

Derivatives hedging at EADS was centralized function managed at the group level by the Corporate Treasury.
It was responsible for setting the parameters of EADS’ hedging policy such as the hedging time horizon, hedge coverage ratios for eligible exposure, monthly amounts for new derivatives purchases, and the mix of hedging instruments.
To facilitate the execution of hedges at Airbus, the Committee had designed a mechanical hedging approach known as the “Speed Grid”

This tool determined the weekly amounts of FX forward contracts to purchase in order to execute EADS’ hedging policy

In making hedging decisions, among many other indicators, The Committee and traders employed long-term Purchasing Power Parity (PPP) models provides by leading investment banks to forecast the $/€ exchange rate

Two group in Treasury
Front Office
was responsible for the execution of hedges in line with hedging policies and current market conditions set by the Committee
Middle office
responsible for verifying adherence to the Committee’s hedging policies, evaluating and selecting hedging counter parties, as well as monitoring credit risk and hedge limits, measuring accounting compliance of EADS’ derivatives with hedge accounting rules, and providing information to investor relations.

Hedge Accounting

EADS’ had to report under International Financial Reporting Standards (IFRS)
IFRS required that financial instruments be marked to their market value at the end of each reporting period.
Difference between a currency’s spot exchange rate and an FX derivative contract’s delivery rate had to be recorded in the accounts of hedging counter parties.
Change in market value were recorded in the company’s equity accounts and did not pass through its current period income statement.

Counterparty risk

The problem with hedge portfolio is that it has either a positive or negative mark-to-market value and neither is 100% good for EADS.
If the company have a negative value on several billion worth of forward contracts, a bank gains, but the company become riskier for client and client become cautions about entering new deals.
If the company mark-to-market on the same portfolio is positive, banks lose money and the company become concerned about big write-offs if banks are at risk of failing and not meeting their obligations.

Mounting FX pressure at airbus
Whether to continue hedging primarily with forward contracts, begin utilizing FX options in much larger amounts, or no further hedging at all
How much of their eligible exposure Airbus should cover?
Currency Foward
A binding contract in the foreign exchange market that locks in the exchange rate for the purchase or sale of a currency on a future date
A contract that grants the holder the right, but not the obligation, to buy or sell currency at a specified exchange rate during a specified period of time. For this right, a premium is paid to the broker, which will vary depending on the number of contracts purchased.
Currency Option
The biggest difference between forward and options is that forward contracts require that the transaction specified by the contract must take place on the date specified. Options, on the other hand, give the buyer of the contract the right — but not the obligation — to execute the transaction.

Natural Hedge
A natural hedge is an investment that reduces the undesired risk by matching cash flows (i.e. revenues and expenses). For example, an exporter to the United States faces a risk of changes in the value of the U.S. dollar and chooses to open a production facility in that market to match its expected sales revenue to its cost structure.
In the first quarter of 2008, the implied volatility of the $/€ exhange rate increased from 7% to 11%.

EADS share price declined from €21.8 per share to €15 (31% drop)

$/ € hedge book stood at only $44.7 billion, its less than half of total hedgeable exposure of $94.2 billion in April 2008

Responding to the FX Risk Challenge
The gap arose in part because of the application of EADS speed Grid, so the pace of weekly hedging decrease as the $/€ forward exchange rate rose.

Responding to the FX Risk Challenge
Identify several possible approaches to cover the outstanding FX exposure with derivative financial instruments:

Reset the speed grid to permit more rapid weekly hedging using forward contracts.
Enter into a single large foward contract within the next month to close the exposure gap
Buy FX option over the course of the next month to cover the outstanding exposure.
Considerations in the Purchase of FX Options
The $/€ exchange rate’s volatility was one of the main drivers of an option’s price given the prevailing spot exchange rate, the option’s exercise price and maturity

If taking forward, all changes in the intrinsic value of this instrument caused by exchange rate fluctuations were recorded in the “other comprehensive income” equity account.

If taking option, had both intrinsic and time value components and changes in the latter required marking to market through the profit and loss account, which increased possible earnings valotility.

The treasury team indicated, that buying an option was more advantageous for EADS banks from a credit counterparty risk perspective. Contrary to a forward, an option could, but did not have to be executed at maturity, which minimazed banks risk on EADS potential default.
Annisa Swavira
Iefty Rinjayuni Nipparchi
Rayhan Armand Nasution
Sirad Handito
Veby Zhera Kansil
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