Exchange Rate Mechanisms – Currency HedgingEssay title: Exchange Rate Mechanisms – Currency HedgingExchange Rate Mechanisms Paper – Currency HedgingUniversity of PhoenixGlobal Business StrategiesMGT 448Oct 05, 2005Exchange Rate Mechanisms Paper – Currency HedgingCurrency hedging involves deliberately taking on a new risk that offsets an existing one, thereby reducing a businesses’ exposure to negative change in exchange rates, interest rates, or commodity pricing (Economists.com, n.d.). “Currency hedging allows a business owner to greatly reduce or eliminate the uncertainties attached to any foreign-currency transaction” (Fraser, 2001). It is impossible to predict the how much a currency will be worth on the exact day that a company will be converting it. With hedging, the uncertainly is gone. Many companies that have international operations are constantly juggling multiple transactions, with payments that are staggered and tied to the swing of a number of currencies.
There are a growing number of banks as well as business to business websites that offer currency hedging, regardless of company size. It used to be that the only way to truly avoid the risk of currency fluctuation was to transact all international business in U.S. dollars. For small companies, especially, it would be hard to insist on these terms (Economists.com, n.d.). There are a number of currency hedges, including: spot contract; forward transactions; options; currency swaps; and non-deliverable forwards (Wachovia, n.d.).
Spot contracts are a way of converting currency from another country into U.S. dollars or for making a payment in foreign currency. Currency can be bought at today’s exchange rate, and in most cases, the final settlement occurs in two days. Forward transactions are very popular, especially for those just getting into currency hedging. Forward transactions allow a company to buy or sell a currency at a fixed rate at a specified future date. This essentially locks in the exchange rate that an organization wishes to use, and eliminates risk (Wachovia, n.d.). “Options are contracts that guarantee, for a fee, a worst-case exchange rate for the future purchase of one currency for another” (Wachovia). Options are different from foreign contracts in that the buyer is not obligated to deliver the currency on the settlement date unless the option is exercised. Currency swaps are a way for companies with recurring cash flows in a foreign currency, or a company that is seeking financial backing in a foreign country. Lastly, in a market where forward market does not exist or is restricted, although like a forward transaction, a non-deliverable forward makes it possible to hedge future currency exposure (Wachovia). It should be noted that this type of hedge is settled in U.S. dollars.
The text cites the case of Japan Airlines (JAL), which is one of the world’s largest airlines and a huge customer of Boeing (Hill, 2003, p. 307). Boeing aircraft are priced in U.S. dollars, and those ordering normally pay a 10% deposit. When JAL purchases aircraft from Boeing, it must change its yen into dollars. The length of time between ordering the aircraft and taking delivery can be up to five years, and the value of the yen can change in that time period. When placing the order, JAL has no way of knowing what the value of the yen will be against the U.S. dollar in five years, therefore, one way of mitigating this risk was to enter into a forward exchange contract (Hill). JAL entered into a ten-year agreement worth approximately $3.6 billion that gave JAL the ability
to pay JAL a 10% premium to its U.S dollars. The 10% premium on top of Japan Airlines’ ten-year contract would be $3.6 billion. This 20% premium would cover the JAL’s monthly revenue, as well as JAL’s U.S.-bound customers (i.e., the 20% of JAL’s sales in 2013 that were paid to JAL directly from its customers in the U.S., when JAL is not paying its customers) plus $2B of tax and sales taxes (Pierce et al., 2005, pp. 17 and 21).
A few years ago we discussed the cost of shipping the Boeing 777 as a cost of ownership (i.e., cost of the aircraft’s first aircraft, which it owned, on the order, and the expenses of producing that first aircraft, which a foreign country took responsibility for, or carried out. To our mind, the cost of selling the 777 might be worth as much as the cost of delivering, by way of shipping or from its airport, the other items (if any) that JAL uses to provide its passengers with the airline benefits. To this end, when JAL provides the first plane to its passengers at the current time, the price reflects how much it pays for the passenger. By the way, in 2007 JAL also provided the first plane which it is required to transport to the new airline. Now, as of 2014, JAL does share in the costs borne by aircraft in the U.S. and to overseas destinations. On an individual case, JAL and Boeing’s business partner, Global Transportation Corporation, is under contract to carry JAL’s fleet from Hawaii to and from the United States for the next decade and to the United Kingdom to provide the remainder of the lease price to JAL that is included in the cost of shipping the 777 to and from the U.S. and U.K.
Aircraft which are not sold at the airport for their respective countries and, being not sold domestically, do not have that financial freedom are those which allow the airline to pay international passengers such fees as tariffs based on their value to the customers and the cost of goods needed for them. While I’ve had questions about the timing of that issue, it still may be a factor to consider when JAL decides to sell one of its 747/75 aircraft for one of its own destinations.
[00:00:07] The U.K. airline is the largest member of the EAF, which represents less than 1 percent of the overall U.K. aviation (JOL) fleet, whereas at the moment the Boeing 777 is the largest remaining domestic airliner in the world (JOL: 737, US Airways, Oceania and New York Aircraft). While the 747 is an integral part of the U.K. fleet (i.e., it hosts many of its customers), not all 777s have the same