Risks for Domestic Airlines Case Solution & Answer

Question 7

First of all, the simulated values for the earnings, jet kerosene and the AUD hav

e been copied in a new excel sheet. Moreover, based upon this set of the data, the correlation has been computed between earnings with jet kerosene and with AUD respectively. The correlation values are -76.08% and – 85.48%. In addition, the minimum variance hedge ratio has been computed for hedging the fuel price risk and the currency risk and both the ratios are negative because the correlation is negative. Lastly, in the last part of this question the regression analysis has been performed as shown in the excel spreadsheet.
The regression model has been formulated by taking earnings as the dependent variable and the jet kerosene and the AUD exchange rate as the independent variable. The correlation for the dependent and both the independent variables has been calculated to be 86.01%. This shows that the jet fuel and the exchange rates both tend to have a significant and strong impact upon the earnings.

However, in order to determine that whether this dependency is significant or not, the p- value in the ANOVA table needs to be analyzed. The p value is 0% which shows that the formulated regression model is significant and fitted and the variation caused in the total earnings as a result of the exchange rate movements between AUD and USD and the jet fuel prices is significant. Lastly, the coefficients table shows the percentage changes with the respective values of Beta for the jet fuel and the exchange rate movements.

After performing all the analysis as shown in all the above parts, if Jet Safe is motivated to hedge the market risk, then there are a number of the options available to the company to hedge for the market risk as a result of the changes in the jet fuel prices and fluctuations in the exchange rates(Cobbs, 2004).

Hedging Fuel Price Risk

In order to hedge for the fuel price risk, the management of the company could make use of the futures contract(Morrell P, 2006). Under the futures contract, the company makes an agreement with another party through a futures exchange for the buying and selling of a commodity such as the jet fuel in this case at a specified price, at a specific time and in specific quantities. The futures contract could be arranged in manner under which the delivery of the asset would take place at the time of the settlement date rather than the cash settlement. The correlation between the earnings and the jet fuel prices is negative and this shows that if the company hedges the fuel price risk, then the company would be saved from incurring losses as a result of changes in the prices of jet kerosene.

Hedging Currency Risk

If the management of the company wants to hedge against the adverse exchange rate movements which might impact upon the profits of the company, then the management has several options to hedge its risk(Morrell P, 2006). The company could enter into a forward agreement and lock in the future exchange rate. This would ensure consistency of the cash flows of the company. Another option available to the management is to make use of the currency options. Under this the management will have the right but not the obligation to buy or sell currency at the specified strike price. ………………………..

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