FX Risk Hedging at EADs Case Solution And Analysis, HBR Case Study Solution & Analysis of Harvard Case Studies

Problem Diagnosis

Finally it was in the year 2008, when the management of European Aeronautic Defense and Space Company which owned Airbus, started to think over the issue which had began in the year 2006. The issue related to how to bets hedge the exposure to which the company was being exposed as a result of the mismatch between the dollar revenues of the company and the payments made for the manufacturing costs in euro.

fx risk hedging at eads case solution

The company currently hedged its foreign exchange exposure through the forward contracts however, as the size of the revenues and the volumes of the company became much higher therefore, the company had to think about changing its hedging strategy and breaks its past practice as the exchange rates were becoming significantly unfavorable. However if a change is made to the policy of the company then it is going to have many consequences for the cash flows, profitability and the ability or the capability of the company to fund its strategic investments.

European Aeronautic Defense and Space Company is competing in a duopoly market with Boeing and therefore, in order to remain competitive in the market it would have to analyze the rationale behind the risk management policy, measure the foreign exchange exposure in the best way possible. Other issues such as hedging with option as compared to futures, hedge accounting and counter party risk would also be important.

Analysis

A range of issues have been analyzed and new policy changes have been evaluated in this section.

Aims of EAD, its policy and FX risk management system

The aim of European Aeronautic Defense and Space Company is strategic in nature and it aims to become the worldwide leader in the space and air platforms and also in systems. Along with this the other goal of the company was to achieve the revenues of about 80 billion euro till the year 2020. Furthermore, the current priorities have also been set by the management of the company in 2008 which include achieving EBIT margins of 10% by 2015, potential acquisitions for the defense and security division and then justifying the production of the goods in United States.

There was a significant mismatch between the dollar revenues of the company and the manufacturing costs of the company incurred in euro. The ability of the Airbus was significantly affected by the changes and fluctuations in the euro and sterling exchange rate which in turn impacted upon the dollar. Furthermore, the company was also exposed to the transactional risk which resulted in different time lags between the actual cash settlement date and the payment commitments date.

Therefore, in order to mitigate the exposure of the firm to adverse currency movements the management of the company had taken the double-pronged approach under which the management of the company mitigated the risk through the operating decisions and minimized the risk through the use of the derivative products. In first place the company took the advantage of natural hedges such as off-shoring and taking the restructuring initiative to convert the cost base in euro into dollars.

Secondly, the company made the use of financial instruments such as the forward contracts under which the management of the company locked the future exchange rates. The main purpose of the management to use these strategies was to protect the decline of the EBIT of the company against the expectations of the shareholders.

System with complete hedging

The system would be changed completely if the transactions exposure, economic exposure and the translation exposure is hedged completely by the management of the company. In the first place if the transaction exposure is hedged completely then the company would be protected from any potential losses being incurred by the company. This is going to save EAD from all the risks that arise from the international trade practices of the company and the fluctuations in the exchange rates would not impact upon the future orders that are expected to be received by Airbus.

FX Risk Hedging at EADs Case Solution

Secondly, if the economic exposure facing the company is completely hedged then the earnings of the company specially the EBIT margins of the company, its investments in the foreign markets and the cash flows of the company would be protected from the adverse exchange rate movements. Lastly, if the company hedges its translation exposure completely then the consolidated financial statement of the company and the values of liabilities, assets and income would not change as the exchange rates change and this would smooth the earnings of the company.................

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