Case AIFS

1
Case analysis

The American Institute for Foreign Study (AIFS) is dedicated to perform cultural exchange

program around the world. They have sent abroad more than 50,000 students. It’s divided

into two categories, the College division that sends student abroad during the academic

year or for the summer. And the high school division that organizes chaperoned

educational travel from 1-4 weeks.

So, what gives rise to the currency exposure at AIFS? Most of their income is in U.S.

dollar, but has expenses in GBP and Euro, resulting on a rise in exposure to currency

risk. They set prices for their programs before any decision on purchasing foreign

currency (hedge) to protect themselves from unfavorable changes in currency rate is

made. Hedging also helps them to prevent the 3 major risk AIFS has:

1. The bottom-line risk: Unexpected foreign exchanges rate would increase the cost

base, leaving them out of market.

2. Sales volume risk (forecast 25,000): Since it is a program based on projected

sales, if the actual sales at the end of the financial period are lower than expected

it could damage financially the company.

3. Hedging against its competitive pricing risk. Due to the amount of transactions

AIFS hedging program represents, it’s good/close relationship with the 6 different

institutions they do their financing with, the banks can hedge their lines of credit

saving them all transaction cost that each transaction requires (deposits).

2
Each year AIFS generates catalogs for both of their divisions, College and High School.

For the college division it is a one-year anticipation catalogue, meaning that for the

summer and fall of next year pricing was set in the current year. For AIFS their clients are

the most important and having “surprise prices covered” is not allowed, no matter what

happens around the world (for example 09/11 was a huge drop in the program sales).

Being established that hedging is their main protection to exposure to currency risk. And

that it needs to operate worldwide due to the nature of business.

So, if Archer-Lock and Tabaczynski do not hedge at all, they would be fully exposing

the program to financial failure as it follows:

Stable Strong Weak

Cost USD 30,500,000 25,250,000 37,000,000
Not hedge Impact 0 5,250,000 -6,500,000

Fluctuations in exchange rate would impact their revenues and expenses (gain or

loss). If the dollar depreciates, AIFS revenues would drop and expenses rise (Euro) the

firm would be in trouble and might get out of the market, due to the fact that their expenses

are mainly in foreign currency, making AIFS bottom line to fluctuate more.

Considering that the cost per participant will be €1,000.00 and forecast sales are 25,000.

The “zero impact” scenario it is determine by the forecast sales at an exchange rate of

$1.22 per euro, resulting in a total expected cost of $30.5m.

3
As shown in the previous table in a strong market the maximum gain is 5,250,000 USD

when the Dollar is strong. The maximum loss in weak market is for 6,500,000 USD, this

since income is in US dollars(weakened) and expenses are in stronger euro.

Following the idea of the zero-impact scenario, what would happen with a 100% hedge

with forwards? If AIFS were to use 100% forward contracts, they would be fully covered

if they accurately predict the amount and time of payments and incurring in a possible

loss of maximum $ 145,000 USD (at stable 1.22 rate) and using 100% options, currency

risk would be covered, and they would pay the option premium of $1,525,000.

Cost of covering the operations:

But it is important consider that the 100% contract and the 100% option scenarios impact

drastically if the rate moves to the weak and strong currency scenarios. Iterations at 1.01

usd/eur (strong) and at 1.48 usd/eur (weak) showed that when the company cover all

their exposition gains and losses fluctuate greatly. For example, at a strong market, the

100% contract the maximum loss is -5,395,000 USD, while the 100% options still limiting

1
Exhibit 2

4
the cost to the premium. And at the weak market, the 100% forward gains 6,355,000 USD

while the 100% option gains 4,975,000 USD.

Therefore, the total cost incurred by AIFS in every scenario are:

Cost Budget 30,500,000

No hedge 25,250,000 37,000,000

Stable Strong Weak

1.22 1.01 1.48

32,025,000 26,775,000 32,025,000
31,680,000 27,742,500 31,680,000
31,335,000 28,710,000 31,335,000
30,990,000 29,677,500 30,990,000
30,645,000 30,645,000 30,645,000

Therefore, what happens if sales volumes are lower or higher than expected as

outlined at the end of the case?

In that case, if sale volume is lower the exposition of the company would be lower but to

their profits. In the other hand, if sales are higher exposition is higher but potential profits

are too.

Exposition at 10,000 volumes:

Stable Strong Weak

Cost USD 12,200,000 10,100,000 14,800,000
Not hedge Impact 0 2,100,000 -2,600,000

Costs of hedging at 10,000 volumes:

5
 Stable Strong Weak
10,000,000 10,000,000 10,000,000
% cover Contracts Options 1.22 1.01 1.48
100% 0% 100% -610,000 -610,000 1,990,000
100% 25% 75% -472,000 -997,000 2,128,000
100% 50% 50% -334,000 -1,384,000 2,266,000
100% 75% 25% -196,000 -1,771,000 2,404,000
100% 100% 0% -58,000 -2,158,000 2,542,000

Exposition at 30,000 volumes:

Stable Strong Weak

Cost USD 36,600,000 30,300,000 44,400,000
Not hedge Impact 0 6,300,000 -7,800,000

Costs of hedging at 30,000 volume

Stable Strong Weak

30,000,000 30,000,000 30,000,000
% cover Contracts Options 1.22 1.01 1.48
100% 0% 100% -1,830,000 -1,830,000 5,970,000
100% 25% 75% -1,416,000 -2,991,000 6,384,000
100% 50% 50% -1,002,000 -4,152,000 6,798,000
100% 75% 25% -588,000 -5,313,000 7,212,000
100% 100% 0% -174,000 -6,474,000 7,626,000

Nevertheless, in terms of the options and contracts the decision shall take into

consideration the risk the company is willing to take, since the variations of the possible

gain and loses grow and decrease with volume. If either options or futures are acquired

with anticipation and sales are not as expected, a not necessary premium could be paid,

only increasing hedging costs.

6
Recommendation

There are additional considerations the company should take into account in order

to determine what is more likely to happen with the exchange rate between the Euro and

the USD, such as political, economic, cultural and legal factors. Also, trends that could

impact their estimated sales for the year to come.

Based on the data showed, we consider that the company should hedge all of the

estimated sales, which would represent 25,000 in volume and a total cost in EUR of

30,500,000. Initially the recommendation was focused on not only the exchange risk, but

also the risk of not completing the sales, and therefore additional premium to be paid for

non-existing sales.

The first approach was the following: In the case of a 25,000 volume the

recommendation is to leave 25% of the total costs without hedge. Since their sales are

not 100% certain, leaving a part of the sales without hedging would limit the amount of

premium to be paid with any of the instruments. By doing this, the maximum exposition

(loss) would be 25% of the weak USD (1.48) scenario:

5,250,000 * 25% = 1,312,500 (gain)

or

6,500,000*25%= 1,625,000 (loss)

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The remaining 75% amount can be protected by using 100% options contract with a

premium of 1,143,750 (loss), but with the potential to not execute the option if the USD

market goes weak, meaning a 3,731,250 gain since option will cover the difference.

But once the information was analyzed, it was determined that there could be a

higher net impact if the USD goes weak against the Euro than the impact generated for

not reaching the estimated sales and paying the option premium,

Hence our final recommendation is to hedge 100% of the estimated sales at a

1-year option. Due to the current politic and economic situation in the USA, we consider

that the Euro is on a stronger position in the year to come, especially is BREXIT is not

enforced and a second referendum is made, thus leaving the USD at risk of weakening

against the Euro. As it was previously said, a deeper analysis would include the global

factors affecting the exchange rate for both currencies. The total cost incurred by AFIS
Cost Budget 30,500,000
would look as it follows:
No hedge 25,250,000 37,000,000

Stable Strong Weak

1.22 1.01 1.48

32,025,000 26,775,000 32,025,000

In which deviations for higher costs are limited by the option (only incurring in the

cost of premium) but gains for possible straightening still there for AIFS to take, even

though the current market does not seem to be going that way.

8
Exhibit 1 at 10,000 volume

AIFS Case
Stable Strong Weak
First Approach Cost USD 12,200,000 10,100,000 14,800,000
Sales 10000 students Not hedge Impact 0 2,100,000 -2,600,000
Cost per student 1000 Euro
FORWARD COST Option Cost (long call) Total Cost (deviation from budget) Cost Budget 12,200,000
Scenarios
Stable 1.22 Usd/eur No hedge 10,100,000 14,800,000
Strong 1.01 Usd/eur
Weak 1.48 Usd/eur Scenario Stable Strong Weak Stable Strong Weak Stable Strong Weak Stable Strong Weak
Total cost (eur) 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000
Option premium 5% 61000 % cover Contracts Options Rate USD/EUR 1.22 1.01 1.48 1.22 1.01 1.48 1.22 1.01 1.48 1.22 1.01 1.48
Strike price 1.22 100% 0% 100% 0 0 0 -610,000 -610,000 1,990,000 -610,000 -610,000 1,990,000 12,810,000 10,710,000 12,810,000
100% 25% 75% -14,500 -539,500 635,500 -457,500 -457,500 1,492,500 -472,000 -997,000 2,128,000 12,672,000 11,097,000 12,672,000
Contract Rates Spot 6M 1Y 100% 50% 50% -29,000 -1,079,000 1,271,000 -305,000 -305,000 995,000 -334,000 -1,384,000 2,266,000 12,534,000 11,484,000 12,534,000
EUR 1.2273 1.2245 1.2258 100% 75% 25% -43,500 -1,618,500 1,906,500 -152,500 -152,500 497,500 -196,000 -1,771,000 2,404,000 12,396,000 11,871,000 12,396,000
GBP 1.8458 1.8169 1.793 100% 100% 0% -58,000 -2,158,000 2,542,000 0 0 0 -58,000 -2,158,000 2,542,000 12,258,000 12,258,000 12,258,000

75% 0% 100% 0 0 0 -457,500 -457,500 1,492,500 -457,500 -457,500 1,492,500 12,657,500 10,557,500 13,307,500
75% 25% 75% -10,875 -404,625 476,625 -343,125 -343,125 1,119,375 -354,000 -747,750 1,596,000 12,554,000 10,847,750 13,204,000
75% 50% 50% -21,750 -809,250 953,250 -228,750 -228,750 746,250 -250,500 -1,038,000 1,699,500 12,450,500 11,138,000 13,100,500
75% 75% 25% -32,625 -1,213,875 1,429,875 -114,375 -114,375 373,125 -147,000 -1,328,250 1,803,000 12,347,000 11,428,250 12,997,000
75% 100% 0% -43,500 -1,618,500 1,906,500 0 0 0 -43,500 -1,618,500 1,906,500 12,243,500 11,718,500 12,893,500

50% 0% 100% 0 0 0 -305,000 -305,000 995,000 -305,000 -305,000 995,000 12,505,000 10,405,000 13,805,000
50% 25% 75% -7,250 -269,750 317,750 -228,750 -228,750 746,250 -236,000 -498,500 1,064,000 12,436,000 10,598,500 13,736,000
50% 50% 50% -14,500 -539,500 635,500 -152,500 -152,500 497,500 -167,000 -692,000 1,133,000 12,367,000 10,792,000 13,667,000
50% 75% 25% -21,750 -809,250 953,250 -76,250 -76,250 248,750 -98,000 -885,500 1,202,000 12,298,000 10,985,500 13,598,000
50% 100% 0% -29,000 -1,079,000 1,271,000 0 0 0 -29,000 -1,079,000 1,271,000 12,229,000 11,179,000 13,529,000

25% 0% 100% 0 0 0 -152,500 -152,500 497,500 -152,500 -152,500 497,500 12,352,500 10,252,500 14,302,500
25% 25% 75% -3,625 -134,875 158,875 -114,375 -114,375 373,125 -118,000 -249,250 532,000 12,318,000 10,349,250 14,268,000
25% 50% 50% -7,250 -269,750 317,750 -76,250 -76,250 248,750 -83,500 -346,000 566,500 12,283,500 10,446,000 14,233,500
25% 75% 25% -10,875 -404,625 476,625 -38,125 -38,125 124,375 -49,000 -442,750 601,000 12,249,000 10,542,750 14,199,000
25% 100% 0% -14,500 -539,500 635,500 0 0 0 -14,500 -539,500 635,500 12,214,500 10,639,500 14,164,500

0% 0% 0%

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Exhibit 2 at 25,000 volume

AIFS Case
Stable Strong Weak
First Approach Cost USD 30,500,000 25,250,000 37,000,000
Sales 25000 students Not hedge Impact 0 5,250,000 -6,500,000
Cost per student 1000 Euro
FORWARD COST Option Cost (long call) Total Cost (deviation from budget) Cost Budget 30,500,000
Scenarios
Stable 1.22 Usd/eur No hedge 25,250,000 37,000,000
Strong 1.01 Usd/eur
Weak 1.48 Usd/eur Scenario Stable Strong Weak Stable Strong Weak Stable Strong Weak Stable Strong Weak
Total cost (eur) 25,000,000 25,000,000 25,000,000 25,000,000 25,000,000 25,000,000 25,000,000 25,000,000 25,000,000
Option premium 5% 61000 % cover Contracts Options Rate USD/EUR 1.22 1.01 1.48 1.22 1.01 1.48 1.22 1.01 1.48 1.22 1.01 1.48
Strike price 1.22 100% 0% 100% 0 0 0 -1,525,000 -1,525,000 4,975,000 -1,525,000 -1,525,000 4,975,000 32,025,000 26,775,000 32,025,000
100% 25% 75% -36,250 -1,348,750 1,588,750 -1,143,750 -1,143,750 3,731,250 -1,180,000 -2,492,500 5,320,000 31,680,000 27,742,500 31,680,000
Contract Rates Spot 6M 1Y 100% 50% 50% -72,500 -2,697,500 3,177,500 -762,500 -762,500 2,487,500 -835,000 -3,460,000 5,665,000 31,335,000 28,710,000 31,335,000
EUR 1.2273 1.2245 1.2258 100% 75% 25% -108,750 -4,046,250 4,766,250 -381,250 -381,250 1,243,750 -490,000 -4,427,500 6,010,000 30,990,000 29,677,500 30,990,000
GBP 1.8458 1.8169 1.793 100% 100% 0% -145,000 -5,395,000 6,355,000 0 0 0 -145,000 -5,395,000 6,355,000 30,645,000 30,645,000 30,645,000

75% 0% 100% 0 0 0 -1,143,750 -1,143,750 3,731,250 -1,143,750 -1,143,750 3,731,250 31,643,750 26,393,750 33,268,750
75% 25% 75% -27,188 -1,011,563 1,191,563 -857,813 -857,813 2,798,438 -885,000 -1,869,375 3,990,000 31,385,000 27,119,375 33,010,000
75% 50% 50% -54,375 -2,023,125 2,383,125 -571,875 -571,875 1,865,625 -626,250 -2,595,000 4,248,750 31,126,250 27,845,000 32,751,250
75% 75% 25% -81,563 -3,034,688 3,574,688 -285,938 -285,938 932,813 -367,500 -3,320,625 4,507,500 30,867,500 28,570,625 32,492,500
75% 100% 0% -108,750 -4,046,250 4,766,250 0 0 0 -108,750 -4,046,250 4,766,250 30,608,750 29,296,250 32,233,750

50% 0% 100% 0 0 0 -762,500 -762,500 2,487,500 -762,500 -762,500 2,487,500 31,262,500 26,012,500 34,512,500
50% 25% 75% -18,125 -674,375 794,375 -571,875 -571,875 1,865,625 -590,000 -1,246,250 2,660,000 31,090,000 26,496,250 34,340,000
50% 50% 50% -36,250 -1,348,750 1,588,750 -381,250 -381,250 1,243,750 -417,500 -1,730,000 2,832,500 30,917,500 26,980,000 34,167,500
50% 75% 25% -54,375 -2,023,125 2,383,125 -190,625 -190,625 621,875 -245,000 -2,213,750 3,005,000 30,745,000 27,463,750 33,995,000
50% 100% 0% -72,500 -2,697,500 3,177,500 0 0 0 -72,500 -2,697,500 3,177,500 30,572,500 27,947,500 33,822,500

25% 0% 100% 0 0 0 -381,250 -381,250 1,243,750 -381,250 -381,250 1,243,750 30,881,250 25,631,250 35,756,250
25% 25% 75% -9,063 -337,188 397,188 -285,938 -285,938 932,813 -295,000 -623,125 1,330,000 30,795,000 25,873,125 35,670,000
25% 50% 50% -18,125 -674,375 794,375 -190,625 -190,625 621,875 -208,750 -865,000 1,416,250 30,708,750 26,115,000 35,583,750
25% 75% 25% -27,188 -1,011,563 1,191,563 -95,313 -95,313 310,938 -122,500 -1,106,875 1,502,500 30,622,500 26,356,875 35,497,500
25% 100% 0% -36,250 -1,348,750 1,588,750 0 0 0 -36,250 -1,348,750 1,588,750 30,536,250 26,598,750 35,411,250

0% 0% 0%

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Exhibit 3 at 30,000 volume

AIFS Case
Stable Strong Weak
First Approach Cost USD 36,600,000 30,300,000 44,400,000
Sales 30000 students Not hedge Impact 0 6,300,000 -7,800,000
Cost per student 1000 Euro
FORWARD COST Option Cost (long call) Total Cost (deviation from budget) Cost Budget 36,600,000
Scenarios
Stable 1.22 Usd/eur No hedge 30,300,000 44,400,000
Strong 1.01 Usd/eur
Weak 1.48 Usd/eur Scenario Stable Strong Weak Stable Strong Weak Stable Strong Weak Stable Strong Weak
Total cost (eur) 30,000,000 30,000,000 30,000,000 30,000,000 30,000,000 30,000,000 30,000,000 30,000,000 30,000,000
Option premium 5% 61000 % cover Contracts Options Rate USD/EUR 1.22 1.01 1.48 1.22 1.01 1.48 1.22 1.01 1.48 1.22 1.01 1.48
Strike price 1.22 100% 0% 100% 0 0 0 -1,830,000 -1,830,000 5,970,000 -1,830,000 -1,830,000 5,970,000 38,430,000 32,130,000 38,430,000
100% 25% 75% -43,500 -1,618,500 1,906,500 -1,372,500 -1,372,500 4,477,500 -1,416,000 -2,991,000 6,384,000 38,016,000 33,291,000 38,016,000
Contract Rates Spot 6M 1Y 100% 50% 50% -87,000 -3,237,000 3,813,000 -915,000 -915,000 2,985,000 -1,002,000 -4,152,000 6,798,000 37,602,000 34,452,000 37,602,000
EUR 1.2273 1.2245 1.2258 100% 75% 25% -130,500 -4,855,500 5,719,500 -457,500 -457,500 1,492,500 -588,000 -5,313,000 7,212,000 37,188,000 35,613,000 37,188,000
GBP 1.8458 1.8169 1.793 100% 100% 0% -174,000 -6,474,000 7,626,000 0 0 0 -174,000 -6,474,000 7,626,000 36,774,000 36,774,000 36,774,000

75% 0% 100% 0 0 0 -1,372,500 -1,372,500 4,477,500 -1,372,500 -1,372,500 4,477,500 37,972,500 31,672,500 39,922,500
75% 25% 75% -32,625 -1,213,875 1,429,875 -1,029,375 -1,029,375 3,358,125 -1,062,000 -2,243,250 4,788,000 37,662,000 32,543,250 39,612,000
75% 50% 50% -65,250 -2,427,750 2,859,750 -686,250 -686,250 2,238,750 -751,500 -3,114,000 5,098,500 37,351,500 33,414,000 39,301,500
75% 75% 25% -97,875 -3,641,625 4,289,625 -343,125 -343,125 1,119,375 -441,000 -3,984,750 5,409,000 37,041,000 34,284,750 38,991,000
75% 100% 0% -130,500 -4,855,500 5,719,500 0 0 0 -130,500 -4,855,500 5,719,500 36,730,500 35,155,500 38,680,500

50% 0% 100% 0 0 0 -915,000 -915,000 2,985,000 -915,000 -915,000 2,985,000 37,515,000 31,215,000 41,415,000
50% 25% 75% -21,750 -809,250 953,250 -686,250 -686,250 2,238,750 -708,000 -1,495,500 3,192,000 37,308,000 31,795,500 41,208,000
50% 50% 50% -43,500 -1,618,500 1,906,500 -457,500 -457,500 1,492,500 -501,000 -2,076,000 3,399,000 37,101,000 32,376,000 41,001,000
50% 75% 25% -65,250 -2,427,750 2,859,750 -228,750 -228,750 746,250 -294,000 -2,656,500 3,606,000 36,894,000 32,956,500 40,794,000
50% 100% 0% -87,000 -3,237,000 3,813,000 0 0 0 -87,000 -3,237,000 3,813,000 36,687,000 33,537,000 40,587,000

25% 0% 100% 0 0 0 -457,500 -457,500 1,492,500 -457,500 -457,500 1,492,500 37,057,500 30,757,500 42,907,500
25% 25% 75% -10,875 -404,625 476,625 -343,125 -343,125 1,119,375 -354,000 -747,750 1,596,000 36,954,000 31,047,750 42,804,000
25% 50% 50% -21,750 -809,250 953,250 -228,750 -228,750 746,250 -250,500 -1,038,000 1,699,500 36,850,500 31,338,000 42,700,500
25% 75% 25% -32,625 -1,213,875 1,429,875 -114,375 -114,375 373,125 -147,000 -1,328,250 1,803,000 36,747,000 31,628,250 42,597,000
25% 100% 0% -43,500 -1,618,500 1,906,500 0 0 0 -43,500 -1,618,500 1,906,500 36,643,500 31,918,500 42,493,500

0% 0% 0%

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