Q2 – What would happen if Archer-Lock and Tabaczynski did not hedge at all?

According to the data given in the case, AIFS use to organize programs for students who want to study abroad and also organize the cultural exchange programs. The company has two major divisions those are managed by the Archer-Lock. Tabaczynski, who is the CFO of the study abroad division and the high school travel division, provides finance for these two divisions. Company faces the problem as its revenue is in Dollar denomination and its cost incur is in Euros and British Pounds denominations. These different denomination currency dealing persuade the company to hedge its foreign exchange risks using the different hedging instruments. Tabaczynski uses the currency hedging to secure AIFS’s revenue generating sources and fluctuation of the currency rates. If AIFS would not have gone for hedging then, company had to take full exposure towards the currency risks which would have ultimately resulted in the loss in dollar denominations (if found depreciation in the US dollar). On the other hand, it can also gain the profit if the USD appreciates. In reality, future is unpredictable and the sales volume of the company cannot be predicted accurately and it goes same with the exchange rates. If any of these two variables depreciate in near future than the company would be in loss of millions of dollars. By doing this, the cost would also increase tremendously which would result large amount of funds into costing.  For example, company expects 25,000 students to enroll in their program per year, and if the USD exchanges rates declines to 1.01 per Euro than the company could benefit in terms of increase in revenues of about $5.25 million. However, if the USD exchange rates decline against the Euro currency to USD1.48/Euro, than it would result in loss of USD 6.5 million.

Q3 – What would happen with a 100% hedge with forwards? A 100% hedge with options? Use the Final Sales volume of 25,000 and analyze the possible outcomes relative to the ‘zero impact’ scenario described in the case?

Forward contracts and options are the financial instruments that are used by the companies to hedge their risks in terms of currency exposure or to reduce their risks. The American Institute for Foreign Study can choose either one of them, forward contract, put option or the combination of these two instruments in terms of various proportions. To cover the cost, AIFS needs Euro by using the put options which gives company the right to sell or forward contract to buy Euros in near future for hedging purposes. Further analysis was made on the basis of 100 percent usage of forwards contract or 100 percent usage of options to hedge currency risks. In this analysis the consideration were made on two variables, in which one is the exchange rates fluctuation that are in between of USD 1.01/Euro, USD 1.22/Euro or USD 1.48/Euro and other is the sales volume that has been predicted to be 25,000………………………

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