Hedging at Porsche Case Solution
Porsche is a manufacturer of sports cars, Its headquarter is in Stuttgart, Germany. It was located in Germany and Finland, but its 40-45 percent sales were generated in the US. Porsche is a high-performance carmaker based in Stuttgart, Germany. Porsche sports cars are known for their reliability, best performance and excellent quality. At the end of the year 2009; Porsche’s product line included the Boxster, 911, Cayman sports car and Cayenne SUV.Porsche is known among its competitors as well as its customers for its mature and dynamic work environment. Its first product was named as 911, which was manufactured in 1964 and had become very famous and successful at various stages of its life cycle. The 911 product gained massive importance globally in a very short span of time(Porsche AG , 2017).As we all know, Porsche is owned by Germany, but 40 to 45% of its total revenues are generated from the United States’ market. Here, Porsche’s main competitors are BMW and Mercedes-Benz. BMW and Mercedes have a better service position as compared to Porsche because they are very receptive to expansion, location, and manufacturing opportunities which are critical to the potential growth and success.
Due to high working leverage; the exchange rate is expected to fluctuate rapidly and unexpectedly. Therefore, Porsche needs to guard against the exchange rate fluctuations in order to control the exchange rate risks, as explained above in the case of the United States. Porsche’s competitors, such as: BMW and Mercedes (Mercedes) have developed good strategies for the management of their operational risks. However, Porsche is very concerned about the operational risks of the past, which are affected by the rise and fall of the US dollars against the German currency. To minimize the risks associated with the foreign exchange issues, Porsche has adopted a series of operational risk management strategies, the first of which is competition in the quality of vehicles and sports cars, as well as protection against the exchange rate fluctuations by having aggressive-put options.
History of Porsche Hedging strategy
Porsche faced bankruptcy in 1990s,and after that experience;its management designed a risk management policy to avoid such situations from occurring in the future. So, there are many reasons to hedge Porsche’s foreign exchange risk, the first being an increase of liquidity and leverage on the balance sheet. Furthermore, if a business depends on banks to avoid its liquidity problems; it is because of the reason that having a bank loan is not a right choice for the business, as an enterprise should rely on its internal cash flows as well as its cash and cash equivalents. The company’s second option is to protect itself from the fluctuations in the exchange rate between the US dollar and euro.For profitability, the company hedged the financial risks associated with the devaluation of the US dollar, which ultimately reduced the company’s profitability due to the appreciation of the euro against the US dollar. The same problem was encountered in the 1990s, when the company was unable to defend itself against the devaluation of the U.S. dollar and went bankrupt.The main reason for Porsche’s management is the use of financial derivatives, such as: put and call options, futures and futures contracts to hedge the currency risk and to combine the income costs in dollars. This is the best solution to protect your business from the external risks. The call and put options are exercised by the company after reaching the desired floor, within which the exchange rate risk can be tolerated.
What they did
If we look at the Appendix table of the case’s document; we can see that the US exchange rate against Euro has increased, which means that the US dollar has depreciated against the Euro. By placing it on the ground; Porsche will be able to obtain the minimum euro for every dollar the company earns in the US, and these dollars can be easily exchanged to euros at a given exchange rate. It reflects that Porsche is able to withstand the exchange rate risks and can reduce the aftereffects of the losses it incurred in the 1990s. The hedging strategy developed rapidly in the year 2007, as shown in table in Appendix of the case document, which is a huge profit margin for the company.
From a shareholder’s perspective; Porsche needs to protect its exposure to exchange rate risk, as this was the main reason of the company’s bankruptcy in the 1990s. This is the biggest failure of Porsche, which its management will never forget. Therefore, in this case; the company must take certain precautions to avoid the future deviations.Therefore, exposure to exchange rate risk needs to be protected in order to save the shareholders’investments and to maximize the total assets. Therefore, this hedging strategy is the best strategy for shareholders, because its ultimate goal is to maximize the total assets…………………….
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