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HBS Case: Hedging Currency Risks at AIFS Essay

Instructions: This case should be done individually. You should prepare a written analysis, and hand in two copies of your analysis on April 12 in class. Only hard copies of the case analysis are accepted. I will submit one of the copies to the Dean’s office for assessment purpose. Each student should also bring his/her own copy of the write-up to class, as well as the case itself, so that we can refer to the specifics in our discussion. The text analysis of your case should be about 3-5 pages (double-spaced). You should download the excel spreadsheet for the case at the Blackboard, complete the quantitative analysis using the spreadsheet, and attach the spreadsheet to your case write-up to support your arguments.

Your write-up should begin with an opening paragraph that defines the main problem in the case and your recommended solution. The remainder of your paper should support your conclusion and recommendations. This support should be based on your definition of the problem and inferences that you draw from the facts of the case. Structure is important for your argument to be lucid and transparent.

The grading will be based on the quality of your analysis and writing. Points will be deducted for grammar mistakes and typos.

Your case should address the following questions:

1. What gives rise to the currency exposure at AIFS?

2. What would happen if Archer-Lock and Tabaczynski did not hedge at all?

3. What would happen with a 100% hedge with forwards? A 100% hedge with options? Use the forecast final sales volume of 25,000 and analyze the possible outcomes relative to the “zero impact” scenario described in the case.

4. What happens if sales volumes are lower or higher than expected as outlined at the end of the case?

5. What hedging decision would you advocate?

Key Problem

The American Institute for Foreign Studies (AIFS) organizes study abroad programs and cultural exchanges for American students. The firm’s revenues are mainly in U.S. dollars, but most of its costs are in euros. AIFS sets guaranteed prices for its exchanges and tours a year in advance, before its final sales figures are known. If the dollar depreciates against the Euro during this period, AIFS’s cost would be higher when measuring in dollars, and negatively impact the firm’s profit. In order to hedge its foreign exchange exposure, AIFS can use an appropriate balance between forward contracts and currency options to achieve the goal.

The Case with No Hedging

If the exchange rate remains constant at $1.22/euros then AIFS will not incur a foreign exchange loss or a gain. It would cost $1220 per participant at this exchange rate. If the dollar depreciates against euro, the actual dollar costs would be above $1220, and then there would be a negative impact. If actual dollar costs were lower than expected, the impact would be positive. Thus, with a sales volume of 25,000 participants and the exchange rate rises to $1.48/euros then AIFS will be subject to a loss of $4,391,892. If the exchange rate drops to $1.01/euros then AIFS will save $5,198,020.

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