Cases in International
Finance
Hedging Foreign Exchange Exposure
Case #1: Lufthansa
“If Karl Marx could see what the foreign exchange
market is doing to captains of industry…a successful
corporate executive of one of the world’s prestige
airlines can put on a multimillion dollar currency
speculation – and win – and still get lambasted by the
critics. Its enough to make a capitalist cry!”
Intermarket, 1985
Some interesting Facts…
1926: Lufthansa was born through
the merger of Deutsche Aero Lloyd
and Junkers Luftverkehr – it inherits
its crane logo from DAL
1934: Lufthansa offers its first
transatlantic flight
1990: Lufthansa resumes flights to
Berlin following German unification
1990: Lufthansa joins the star alliance
with Air Canada, SAS, Thai Airlines and
United Airways – the first multinational
airline grouping
Lufthansa Today
Lufthansa is the national carrier of Germany –
headed by Wolfgang Mayrhuber (since 2003)
Revenue (2004): E 17B
Net Income (2004): E 383M
Passengers (2004): 50.9M
Load Factor (2004): 74%
Lufthansa has 253 aircraft with an average age of 10.5 years.
Boeing: 40%
Airbus: 60%
In January 1985, under the Chairmanship of Heinz Ruhnau,
Lufthansa purchased twenty 737 jets from Boeing for $25,000,000
apiece ($500M Total)
Length: 100 Feet
Wingspan: 86 Feet
Cruising Speed: 470 MPH
Max Altitude: 35,000 Feet
Range: 1000 Miles
Seats: 123
At the time, the exchange rate was DM 3.20 per dollar. At this
rate, the planes would cost Lufthansa DM1.6B
Over the previous year, the dollar had been appreciating against
the Deutschmark..
3.3
3.1
DM/$
2.9
2.7
2.5
2.3
2.1
1.9
1.7
1/1/1981
1/1/1982
1/1/1983
1/1/1984
1/1/1985
Lufthansa’s Options
Option #1: Remain Uncovered
The riskiest option with the greatest potential gain (if the dollar
weakens against the Deutschmark) and the greatest potential cost (if the
dollar strengthens).
Option #2: Full Forward Hedge
The safest of the options. If Lufthansa bought dollars forward at
the current rate of 3.2, they could lock in a cost of DM1.6B
Option #3: Option Hedge
If Lufthansa purchased put option on DM at 3.20 DM/$ (or call
options on dollars), they could take advantage of the potential gain from
a dollar depreciation, but still hedge the possible appreciation risk
Lufthansa’s Options
Option #4: Money Market Hedge
Lufthansa could obtain dollars now, by borrowing Deutschmarks,
converting them to dollars at DM 3.20 and then depositing them in either a
US bank or a Eurodollar account until needed. In principle, this should
have the same effect as the forward hedge
Option #5: Partial Hedge
Lufthansa could purchase $250 M dollars forward at DM 3.20 at
allow the remaining balance to be un-hedged.
Option #6: Cash Flow Matching
Lufthansa could try and generate $500M in ticket sales in the US
– very unlikely!
Lufthansa’s Options
2.2
Uncovered
Cost (Billions DM)
2
Full Forward
1.8
1.6
1.4
Option Hedge
1.2
Partial Hedge
1
2.2
2.4
2.6
2.8
3
3.2
3.4
3.6
3.8
4
Ruhnau was convinced that the dollar was going to fall and opted for
the partial hedge. He was proved right as the dollar plummeted in the
mid eighties.
3.5
3.3
3.1
2.9
2.7
2.5
2.3
2.1
1.9
1.7
1.5
1/1/85
5/1/85
9/1/85
1/1/86
5/1/86
9/1/86
1/1/87
5/1/87
9/1/87
Did Ruhnau make the right decision?
Alternative
Uncovered
Put Options
Partial Hedge
Full Forward
Relevant Rate
DM 2.30
DM 2.30 + Premium
.5(2.30) + .5(3.20)
DM 3.20
Total Cost
DM 1.150 B
DM 1.246 B
DM 1.375 B
DM 1.6 B
While Ruhnau was correct on the direction of the dollar, he could
have saved some money using options rather than a partial hedge!
Case #1: Porsche
“Porsche makes most of its cars in Germany,
so its costs are mainly in Euro. Yet a large
chunk of its revenues come from sales in
America. “
The Economist, June 5, 2003
Some interesting Facts…
Porsche was founded in 1931 by
Ferdinand Porsche, a former
Daimler Benz director.
One of the first
Porsche models…look
familiar?
Some interesting Facts…
The first real Porsche – designed
in 1948
September 30, 1955:
James Dean is killed
driving his Porsche
550 Spyder
Porsche Today
Porsche is led by President and CEO Dr.
Wendelin Wiedeking (since 1993)
Net Sales (2003): E 5.582B
Net Income (2003): E 565M
EPS(2003): E 32.29
EPS Growth (2003): 22%
Porsche is essentially a privately held company. All 8.75M voting
shares are held by the Porsche family. The remaining 8.75M nonvoting shares are primarily held by institutional investors
The Jewel in the Porsche Crown has always been the 911 Series.
(14 different 911 models currently)
Engine: 3.6l 6 Cylinder Engine
Power: 325 Hp @ 6,800 RPM
Acceleration: 0-60 in 4.8 Sec.
Top Speed: 177 Mph
Porsche 911 Carrera
Units Sold (2003): 27,789
Average Price: E 92,000
Cost: E 78,000
Profit Margin: 16%
The 911 commands almost
exclusive ownership of its market
segment (high end sports cars).
While sales are cyclical, price
elasticity is very low.
The Boxster was introduced in 1996 to compete with the lowers
end sport scars already on the market.
Engine: 2.7l 6 Cylinder Engine
Power: 240 Hp @ 6,400 RPM
Acceleration: 0-60 in 5.9 Sec.
Top Speed: 160 Mph
Porsche Boxster
Units Sold (2003): 18,411
Average Price: E 44,000
Cost: E 41,000
Profit Margin: 8%
The Boxster is less cyclical than
the 911, but much more price
sensitive – particularly since
introduction of the BMW Z4 in
2003
Porsche recently gained entry into the lucrative SUV market. Fuelled
by SUV crazy Americans, the launch of the Cayenne in 2002 has been
hailed as one of the most successful produce launches in history
Engine: 3.2l 6 Cylinder Engine
Power: 247 Hp @ 6,000 RPM
Acceleration: 0-60 in 8.5 Sec.
Top Speed: 133 Mph
Porsche Cayenne
Units Sold (2003): 20,603
Average Price: E 68,000
Cost: E 61,000
Profit Margin: 10%
The Cayenne is clearly at the high
end for SUVs – Porsche is quickly
moving to develop a lower
powered, lower cost version.
Porsche’s Growing Sales
60000
50000
40000
Cayenne
Boxster
911
30000
20000
10000
0
1994 1995 1996 1997 1998 1999 2000 2001 2002
Porsche’s Competitive Position
Automaker
Sales
(Billions)
Revenue
(Per
Vehicle)
Margin
Debt (% ROIC
of
Assets)
Audi
E 22.6
E 27,000
6.6%
.2%
NA
BMW
E 42.3
E 32,211
8.0%
47.5%
11.3%
Fiat
E 58.2
E 25,829
1.6%
31.3%
-2.9%
Mercedes
E 50.2
E 39,000
6.4%
NA
NA
Peugeot
E 54.4
E 16,192
5.3%
42.9%
10.5%
Porsche
E 5.6
E 72,889
16.4%
6.4%
20.5%
Renault
E 36.3
E 14,250
4.1%
47.6%
3.7%
Volkswagen
E 86.9
E 13,583
5.2%
42.4%
6.8%
“We learned the hard way that banks are never there when you
need them…” : Porsche’s anti-debt philosophy
Porsche’s Foreign Exchange Exposure
United Kingdom
Automaker
United States
Sales
Production
Sales
Production
BMW
11%
15%
26%
11%
Fiat
6%
0%
0%
0%
Mercedes
9%
0%
19%
7%
Peugeot
12%
6%
0%
0%
Porsche
11%
0%
42%
0%
Renault
9%
0%
1%
1%
Volkswagen
7%
0%
13%
7%
Porsche has the heaviest US exposure (and this is increasing), yet it
has the lowest rate of natural hedging in the sector…” (Citigroup)
Pricing Pressures
Porsche’s Newest Model, the 911 Carrera 4s Cabriolet (2003)was
priced in continental Europe at E 85,000 (a 15% markup over cost of
$72,000). Simultaneously, the new Cabriolet was introduced in the
US for $93,000
Implied Exchange Rate =
$ 93,000
E 85,000
= 1.09 $/E (.91 E/$)
EUR/USD
As the Dollar falls, so do profit margin!
At the current $1.29 per Euro exchange rate…
$ 93,000
= E 72,093
1.29 $/E
A profit margin of essentially
zero over the cost of E 72,000!!
Alternatively, Porsche could price to 911 in the US at a lower profit
margin (say, that of the Boxster -8%)
E 72,000(1.08) = E 77,800(1.29) = $100,310
Price elasticity of the 911 is the lowest of the various Porsche
platforms, but could the US market withstand a price increase of this
magnitude? (7.8%)
Porsche’s Problem Defined:
Porsche has three model lines
with different market
characteristics – 45% of
Porsche’s sales are in the US
($1.836B per year)
With the exception of an
assembly plant in Finland (also a
Euro country), all Porsche’s are
manufactured in Germany
As the dollar continues to decline, what options does Porsche
have to cover its currency exposure?
What did Porsche Actually Do?
Porsche chose an aggressive strategy of put options on dollars
(i.e. contracts to sell dollars at a fixed price). Porsche maintains a
3 year rolling portfolio of put options with strike prices based on
currency forecasts. - Sales revenues through model year 2006 are
completely hedged.
Currency Exposure Covered by Derivative Instruments
BMW: 35%
Mercedes: 30%
Porsche: 100%
Volkswagen: 30%
Is this the best strategy?