Hedging Currency Risks at AIFS. Case Solution
2. 100% with Forward Contracts
If the strategy of doing nothing does not work at all, then there is another strategy, which is hedging with 100% forward strategy, however by using this strategy there is no upfront payment. However,in the case of USD/EUR, the price would reduce, after which one cannot step away from the contract, and that one party cannot get the benefit of the profit alone in case of the adverse situation. This contract is no more expansive but has limited flexibility as compared to the options contracts.
3. 100% with Options
This option gives more flexible chances to make the decision on any situation. If the current market price crosses the strike price agreed in contact, then the contract buyer can use the option of right to call, which means that the contract seller will be responsible to fulfill the contract by selling agreed currency on the strike price. However,it would be expensive to the company. Moreover, if the company buys 25 million Euros contracts against the US dollar, then 5% of Notional of US dollars value will be charged as $1.525 million as the expense against the option contracts.
Different levels of hedge strategies provide categorically different values against each other, and if we select 100% forward strategy against 100% target achieved, then there would be three columns portraying three different prices levels, such as stable dollar 1.22, weak dollar 1.01, and strong dollar 1.48.
At stable dollar, the amount would present the cost of the total volume of sales with no hedging strategy and that the amount meets with the projected cost, as a result,there would be no effect unless and otherwise, the US dollar gets stronger or weaker against the Euro.
If the dollar gets stronger against the Euro, then the company would have positive impact, because the carrying cost will decrease, and if the situation is opposite, in which the US dollar gets weaker against Euro, then there will be negative impact.
Therefore, in order to avoid these negative impacts, there are strategies as discussed above, and given in Exhibit 1. The model gives a clear view of categorically three levels with coverage value against the three different price as expected, and each level has different ratios of contract such as options and each level have determined percentage of Contracts and Options as well.
AIFS has three different strategies with different levels of different prices that can take place, there fore there are all possible outcomes given in the table which show that if the dollar is weak then, what will it cost to the organization to make international trip, and in case if the dollar is strong, then the question arises as to what step will the company take.
With respect to the percentage of contract and options given in every level, carrying the cost of options is included in the calculated cost in all three columns, because it will give the clearest view of the situation at that time. In order to face any other situation in the future, the given table will help to project most near values in the future that could meet the future sales forecast……………….
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