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What type of currency exposure is Lufthansa facing?

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In May 2003 Lufthansa purchased 10 jets from Boeing. The agreed upon price was $500,000,000, payable in U.S. dollars on delivery of the aircraft in one year, in May 2004. The Euro had been rising rapidly since 2002 and was approximately 1.2$/Euro or 0.83Euro/$.
The CEO of Lufthansa had his own view or expectations regarding the directions of the exchange rate. Like many others he believed that the Euro would continue to rise until the delivery is due. Therefore, he decided to cover half of his exposure using a forward contract. He bought $250,000,000 at a rate of Euro0.83/$.

  1. What type of currency exposure is Lufthansa facing?

  2. Is hedging appropriate in this case?

  3. What other hedging techniques are possible? Briefly explain:

    1. Forward

    2. Futures

    3. Options

    4. Obtain U.S. dollars now and hold them until payment is due

  4. Compare the final exposure for Lufthansa using:

    1. No Cover

    2. Forward full cover

    3. Forward half cover

    4. Purchase of call options for $500,000,000 at a exercise price of 1.2$/Euro and a premium of Euro30,000,000

  5. What is the total cost for the planes using the four alternatives (question 4) if the currency exchange rate in May 2004 is:

    1. 1$/Euro

    2. 1.5$/Euro

  6. How do you assess the CEO’s decision to cover half of the exposure using forward contracts?

  7. Critics claim that Lufthansa should not purchase Boeing aircraft at all. Germany, as well as other European Union members have a vested interest in the conglomerate Airbus. Also, by buying Airbus Lufthansa could avoid any currency exchange rate risk. How do you respond to this criticism?

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