1. January 23 Alison Catherine Cristiana
Iceair Airlines
January 23
Alison
Catherine
Cristiana

2. Assist Iceair Airlines to increase internal efficiency by:
Mandate
Assist Iceair Airlines to increase internal efficiency by:
Hedging oil prices
Restructuring the defined benefit pension plan
Introduction
Analysis
Implementation
Conclusion

3. Iceair Airline should:
Recommendation
Iceair Airline should:
Hedging oil
Use a put bear spread to hedge the oil price risk
(2) Defined benefit plan
Overweight in equities to meet the 8.3% required rate
(more diversification) + hiring 2 new managers.
This will allow Iceair to be able to focus on expanding its business and achieve pension obligation.
Introduction
Analysis
Implementation
Conclusion

4. Industry Overview Seasonality Social/political events
Peak months
Summer: July, August Winter: January
Depressed months
Summer: April, May Winter: October,November
Social/political events
2012 student protest (decreased vacation in winter)
expected increased flights volume in
summer 2014
Meet demand by increasing the number of flights and destinations
Airline Industry marked by high volatility.
Introduction
Analysis
Implementation
Conclusion

5. Leader in tourism market
Iceair Overview
Leader in tourism market
Specialized in passenger air transportation & vacation packages
Vertical integration
Vision
Competitive prices
=> reduce costs (17% gross profit)
Family-oriented clientele
Goals
Increase fleet by 23% in an effort to eliminate leasing
=> increased oil consumption
=> higher exposure to fluctuation in oil prices
Iceair would need to hedge the oil price in order to minimize the greater risk exposer due to increased fleet.
Introduction
Analysis
Implementation
Conclusion

6. Higher exposure to oil price volatility Leader in tourism market
In order to maintain its competitive advantage and strategic vision Iceair needs to increase its fleet
Higher exposure to oil price volatility
Hedge oil price risk
Iceair Overview
Leader in tourism market
Specialized in passenger air transportation & vacation packages
Vertical integration
Vision
Competitive prices
Family-oriented clientele
Goals
Increase fleet by 23% in an effort to eliminate leasing
=> increased oil consumption
=> higher exposure to fluctuation in oil prices
Iceair would need to hedge the oil price in order to minimize the greater risk exposer due to increased fleet.
Introduction
Analysis
Implementation
Conclusion

7. Historically the WTI prices increased by %65 in the past 4 years.
Historical WTI prices
Historically the WTI prices increased by %65 in the past 4 years.
Introduction
Analysis
Implementation
Conclusion

8. Oil Industry Mechanism
Oil Demand
Oil Supply
Slower economic growth in China leading to a reduced oil demand
Over supply in U.S. due to new oil extraction technologies
Discrepancy between supply and demand will lower WTI barrel price
Introduction
Analysis
Implementation
Conclusion

9. Demand considerations
China the second largest oil consumer in the world
China GDP
Oil demand is decreasing because of China’s low growth.
Introduction
Analysis
Implementation
Conclusion

10. Supply considerations
U.S. supply is increasing because of new technology (fracking)
Introduction
Analysis
Implementation
Conclusion

11. We expect that oil price will decrease to $95/barrel by March, 2014.
Expected WTI prices
We expect that oil price will decrease to $95/barrel by March, 2014.
Introduction
Analysis
Implementation
Conclusion

12. The expected WTI price is $95/barrel0
Hedging strategy
We expect that Iceair would need ~830,000 barrels of oil for the month of March
(15% of total annual consumption of oil)
The expected WTI price is $95/barrel0
Need for a strategy that:
Allows Iceair to benefit from the future oil price decrease
Protects Iceair in case of a oil price increase
Offers Iceair the lowest volatility
Introduction
Analysis
Implementation
Conclusion

13. Hedging alternatives 1. Futures
Engage in futures contract of $100/barrel.
Gives the buyer the right and obligation to buy the underlying commodity at a fixed price
Protects in case of price appreciation
High volatility (expected decreasing prices)
Unlimited loss
Introduction
Analysis
Implementation
Conclusion

14. Hedging alternatives 2. Swaps Engage in swaps contract of $100/barrel.
An agreement whereby a floating price is exchanged for a fixed price over a specified time of period.
Provides potential upside if oil price increases
High volatility (expected decreasing prices)
Unlimited loss
Introduction
Analysis
Implementation
Conclusion

15. Provides profit in event of price depreciation
Hedging alternatives
3. Put Bear Spread
Purchase put options at strike price of $100 ($2)
Sell put options at strike price of $90 ($7)
If price decreases below $100, realize $4.15m gain
Option strategy that seeks maximum profit when price of underlying asset declines involving simultaneous purchase and sell of options.
Provides profit in event of price depreciation
Limited loss
Pay premium
Introduction
Analysis
Implementation
Conclusion

16. Hedging Summary
Method
Protect against oil price appreciation
Protect against oil price depreciation
Protect against volatility
Futures Contract
Swaps contract
Put bear spread
Legend:
Met Investment Criteria
Somewhat met Investment Criteria
Didn’t meet investment criteria
The put bear spread offers the best protection against oil price fluctuations

17. Overview of Pension Plan
Current Fund
Defined Pension Benefit Plan
Managed by the Company’s treasurer
AUM of $395M
Actuarial deficit of $30,9M
+++ sustainability
Restructure the portfolio to cover the fund’s deficit
Introduction
Analysis
Implementation
Conclusion

18. Current Portfolio
Fixed Income
Equity
Cash
Allocation
24%
Return
-13%
(10y Cad)
54% 0%
Invest cash, rebalance bond versus equity to attain X% objective while reducing risk
Introduction
Analysis
Implementation
Conclusion

19. Current Asset Allocation
Current Portfolio
Rising Interest Rates in Cnd and US
80% of bond portfolio in long term maturities
Bullish on U.S and Emerging Markets
26% of U.S. equities and 0% in Emerging Markets equities
Cristiana’s analysis
Neutral on Canadian Equities
74% of equities in Canadian equities
Current Asset Allocation doesn’t reflect management projected view on the economy
Introduction
Analysis
Implementation
Conclusion

20. Assessment of Current Managers
Current Asset Allocation doesn’t reflect management projected view on the economy
Introduction
Analysis
Implementation
Conclusion

21. Surplus or Deficit
Cover deficit with Operations
Increase Contribution
Increase Returns
Current Asset Allocation doesn’t reflect management projected view on the economy
Introduction
Analysis
Implementation
Conclusion

22. Goals of Portfolio Restructuring
Cover the Fund’s deficit
$395M
$30.9M in Deficit
No Deficit 8%
8.3%
Rebalance the portfolio considering management views
Bond portfolio vs views on interest rates
Equity portfolio vs expectations on the different markets
Total allocation vs currency risk and tax benefits
Modify Investment Policy Statement
Introduction
Analysis
Implementation
Conclusion

23. Investment Policy Return objective
IceAir needs 8.33% to cover the deficit
Risk Tolerance
Low risk tolerance : capital preservation
Time horizon
25-years investment horizon (close the gap within)
Liquidity needs
Payments to retirees (no immediate need)
Constraints
Maximum 10% in cash, (target at 0%)
Investment in ETF
No weapon, acohol, tabacco
Introduction
Analysis
Implementation
Conclusion

24. Graph with optimal portfolio Bond/Equity return
Expected Return
7,4%
Graph with optimal portfolio Bond/Equity return
Standard Deviation
3,7%
This capital allocation doesn’t meet the fund’s required rate of return to recover its deficit
Introduction
Analysis
Implementation
Conclusion

25. Graph with Bond/Equity return
Proposed Allocation
Expected Return
8.4%
Graph with Bond/Equity return
Standard Deviation
4.0%
The recover the fund and achieve 8.33% return, 42% has to be invested in equities and 58% in bonds
Introduction
Analysis
Implementation
Conclusion

26. Proposed Asset Allocation - Equities
Previous Allocation
Proposed Allocation
Allocation
Return
5,1%
8,4%
The proposed allocation is in line with management views on the economy and recovers the fund’s deficit
Introduction
Analysis
Implementation
Conclusion

27. Current Sector Allocation
Current Portfolio
68% of equities in 2 tourism stocks
Remainder in ETF
graph
Concerns
Highly volatile stocks
2 slides with this
Diversify sector allocation to reduce the exposure to the tourism sector and associated volatility
Introduction
Analysis
Implementation
Conclusion

28. Implementation over 6-12 months
Sector Allocation
Current Portfolio
Concerns
68% of equities in 2 tourism stocks
Remainder in ETF
Highly volatile stocks
Diversification
Implementation over 6-12 months
Eliminate market risk
Reduce volatility
Hire 2 new managers specialized in X and Y
Buy ETF/Stocks (20-30) in different sectors
E.i. Financials, Staples, O&G, etc
2 slides with this
Diversify sector allocation to reduce the exposure to the tourism sector and associated volatility
Introduction
Analysis
Implementation
Conclusion

29. Proposed Portfolio
Fixed Income
Decrease allocation from 63% to 58%
Invest in lower duration bonds
Equities
Increase allocation from 24% to 42%
Higher emphasis on U.S. and Emerging Market Equities
Diversify away from tourism sector
Cash
Target allocation at 0% as we see better opportunities in the market
Hire 2 new fund manager specialized in equities (North America vs. International and Emerging Markets)
Management
We suggest a more diversified sector allocation to reduce the exposure to the tourism sector
Introduction
Analysis
Implementation
Conclusion

30. The new investment policy meets the fund’s goals
Risk and Mitigation
- US investment: hedge right away currency risk: 500 m in usd, forward contracts on the same equity amount on cad to US. Interest rate differential defines forward contract. Hedges over 1 year
Country 5: 5% --- depreciating currency
Country 1%
Interest rate : short term
The new investment policy meets the fund’s goals
Introduction
Analysis
Implementation
Conclusion

31. Goals of Portfolio Restructuration
Cover the Fund’s deficit
$395M
$30.9M in Deficit
No Deficit 8%
8.3%
Rebalance the portfolio considering management views
Bond portfolio vs views on interest rates
Equity portfolio vs expectations on the different markets
Total allocation vs currency risk and tax benefits
The new investment policy meets the fund’s goals
Introduction
Analysis
Implementation
Conclusion

32. Thank you. Q&A
January 22
Alison
Catherine
Cristiana