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Hedging Currency Risk at Aifs

The document discusses how differing sales volumes and exchange rates would impact gains and losses for AIFS. Higher sales volume combined with an unfavorable exchange rate would result in the highest possible losses, while higher sales volume with a favorable exchange rate would produce the highest gains. The option hedge strategy is recommended as it provides the best protection against fluctuations in both exchange rates and sales volumes, which are more likely for AIFS's industry than exchange rate fluctuations alone.

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652 views1 page

Hedging Currency Risk at Aifs

The document discusses how differing sales volumes and exchange rates would impact gains and losses for AIFS. Higher sales volume combined with an unfavorable exchange rate would result in the highest possible losses, while higher sales volume with a favorable exchange rate would produce the highest gains. The option hedge strategy is recommended as it provides the best protection against fluctuations in both exchange rates and sales volumes, which are more likely for AIFS's industry than exchange rate fluctuations alone.

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The higher or lower sales volume would exaggerate whatever gains or losses

AIFS will realize. We are able to utilize the AIFS shifting box to determine what
the reactions to differing sales volume versus the exchange rate. If the volume
is low and the exchange rate is out of the money, the loss will be lower than if
the volume was the same as projected. With a lower sales volume but in the
money interest rate the gain would be realized, however again it would be
smaller than the gain with the expected 25,000 participant value. For a higher
sales volume and out of the money exchange rate the loss would be the highest
possible, which can be hedged by using an option. If the sales volume is high
and the rate is in the money, this would be the highest possible gain, however it
would also require AIFS to buy more currency. This is both good and bad news,
because the exchange rate could be out of the money by the time AIFS is able to
buy more currency. However if the exchange rate was in the money this option
would be the best possible situation, creating the highest revenues of all
possibilities.
The option hedge strategy would be the policy we would advocate because AIFS
purchases foreign currency based on the projected sales volumes. The option
strategy provides the best protection from the fluctuation in both exchange rates
and sales volumes. We believe that due to the industry in which AIFS operates,
the company is more likely to experience higher fluctuations in sales volumes
than in the exchange rates. The option strategy provides a more versatile option
to hedge against this potential risk because AIFS will not be locked into a specific
rate, as is the case with forward hedges

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