1. Jennifer Choi Tommy Fermin Luz Pacheco Ibrahim Shaikh
Group 4
Jennifer Choi
Tommy Fermin
Luz Pacheco
Ibrahim Shaikh

2. Agenda Company Background - Tommy Case Details - Jennifer
Defining the Issues - Luz
Alternative Analysis - Ibrahim
Recommendation - Tommy
Q & A

3. Company Background
Deutsche Lufthansa AG (DLAKY.PK) - founded 1926 in Berlin following merger of Deutsche Aero Lloyd and Junkers Luftverkehr
Luft – “Air” Hansa – “Company”
Symbol of flying and technical expertise
1927 – first flights to China
1934 – first trans-Atlantic flights
1945 to 1955 – air traffic suspended due to war
1960 – enters the jet aircraft age
Incorporated after the Allies lifted the prohibition for German commercial flights imposed after the war
Luft – “air”
Hansa – “company”
Jet aircraft age – no longer propeller driven aircrafts

4. Company Background (cont.)
Sixth largest airline in the world (Second largest in Europe)
Lufthansa Cargo AG is the leading cargo air carrier
Divisions in aircraft maintenance, catering, IT, and leisure/travel businesses
Approx. $23.6 billion 2006 Fiscal YE Revenue
Incorporated after the Allies lifted the prohibition for German commercial flights imposed after the war
Luft – “air”
Hansa – “company”

5. Company Background (cont.)
Operations in Europe, North/South America, Africa, Middle East, and Pac Rim regions (45 million passengers/year)
Main hubs in Frankfurt and Munich
437 aircraft fleet – approx. 60% Airbus, 40% Boeing
Key Competitors: Air France-KLM, AMR Corp, and British Airways
Incorporated after the Allies lifted the prohibition for German commercial flights imposed after the war
Luft – “air”
Hansa – “company”

6. Agenda Company Background - Tommy Case Details - Jennifer
Defining the Issues - Luz
Alternative Analysis - Ibrahim
Recommendation - Tommy
Q & A

7. Case Details: Overview
In January 1985, Lufthansa Chairman Herr Heinz Ruhnau purchased twenty Boeing 737 jets
Total Price = $500 million USD, payable January 1986
USD upward trend against the Deutschmark since 1980
3.2 DM / $1
Ruhnau believed the trend had reached a plateau and would soon decline
Hedge to mitigate exchange rate risk / purchase cost
- Since it was the company’s money, instead of leaving uncovered, purchased forward contracts

8. Case Details: X/C Rate Trend
DM3.2/$
Jan-85
Sourced by

9. Inflation Rate US 1980’s Deregulation - know as “Reagonomics”
Low corporate tax rates & low inflation rates
US Dollar appreciated from
PPP – U.S low inflation rate made it a good place to invest
PPP – Purchasing Power Parity

10. Case Details - Decision Criteria
Ruhnau’s belief that the dollar would depreciate against the Deutschmark
Tolerable level of risk using company’s funds
Limited capital on hand
Balance sheet currency debt restrictions
He had to think about the stockholders
Also they only had limited capital on hand – 500K
Full Forward Cover - Minimum risk: not chosen since Ruhnau felt dollar would decline; most companies want tolerable amount of risk (risk averse)
Lufthansa had strict covenant limiting type, amount, currency of debt it could carry on the balance sheet.

11. Case Details - Outcome
$250 million forward 3.2 DM / $1 ($250 million uncovered)
USD upward trend against the Deutschmark continued through February 1985 and then plummeted
2.3 DM / $1 spot rate in January 1986 (3.2 DM / $1 January 1985)
Total Cost of Boeing Deal
Full Forward Cover - Minimum risk: not chosen since Ruhnau felt dollar would decline; most companies want tolerable amount of risk (risk averse)
Lufthansa had strict covenant limiting type, amount, currency of debt it could carry on the balance sheet

12. Case Details: X/C Rate Trend
Apr-85
DM2.9/$
Jul-85
DM3.2/$
Jan-85
Sourced

13. Case Details – Outcome (cont.)
February 1986, Ruhnau summoned to meet with Lufthansa board of directors over management of exchange rate exposure for the Boeing deal
Criticized by the board for the use of forward contracts as exposure; not for leaving half of the deal uncovered
Full Forward Cover - Minimum risk: not chosen since Ruhnau felt dollar would decline; most companies want tolerable amount of risk (risk averse)
Lufthansa had strict covenant limiting type, amount, currency of debt it could carry on the balance sheet

14. Agenda Company Background - Tommy Case Details - Jennifer
Defining the Issues - Luz
Alternative Analysis - Ibrahim
Recommendation - Tommy
Q & A

15. Defining the Issues Low High Forecast Exchange Rate
Importance
Urgency
Low
High
Forecast Exchange Rate
Financial Health of Company/Shareholders
Type of Planes IV
Exchange Rate Risk
Hedging Method
One key issue – important and urgent, exchange rate risk affects cost, profitability

16. Defining the Issues – Exchange Rate Risk
Importance:
Increased cost of doing business
Negative impact to bottom line
Urgency:
Timing is critical
Volatile movement
Remain Uncovered - Greatest Risk
-If the dollar depreciates against the Deutschemark greatest Benefit
- If the dollar continues to appreciate- greatest Cost
Full Forward Cover -For the very risk adverse. There is no longer any risk to the ending spot rate.
Partial Forward Cover - Cover part of the total exposure and leave the remaining exposure uncovered. 2nd half is still very sensitive to the dollar appreciating to high amounts t
Foreign Currency Option - The total cost is locked at (DM 3.2/$) 1.6 billion.
Cost + Option Premium (6% - DM 96,000,000)
Buy Dollars now - Obtain the 500 million now and hold those funds in an interest bearing account.
Requires company to have all the money now.
Lufthansa had strict covenants in place limiting the types, amounts, and currency denomiantions of debt it could carry in its balance sheet.

17. Defining the Issues – Hedging Methods
Importance:
Need to control costs
Mitigate exchange rate risk
Urgency:
Method selection is critical
Method needs to provide flexibility and tolerable level of risk
Remain Uncovered - Greatest Risk
-If the dollar depreciates against the Deutschemark greatest Benefit
- If the dollar continues to appreciate- greatest Cost
Full Forward Cover -For the very risk adverse. There is no longer any risk to the ending spot rate.
Partial Forward Cover - Cover part of the total exposure and leave the remaining exposure uncovered. 2nd half is still very sensitive to the dollar appreciating to high amounts t
Foreign Currency Option - The total cost is locked at (DM 3.2/$) 1.6 billion.
Cost + Option Premium (6% - DM 96,000,000)
Buy Dollars now - Obtain the 500 million now and hold those funds in an interest bearing account.
Requires company to have all the money now.
Lufthansa had strict covenants in place limiting the types, amounts, and currency denomiantions of debt it could carry in its balance sheet.

18. Defining the Issues - Hedging Methods (cont.)
Remain Uncovered – maximum risk; largest gain/loss possible
Full Forward Cover – minimum risk
Partial Forward Cover – medium risk; uncovered exposure
Foreign Currency Option – low risk; sunk cost (premium); fairly new tool
Buy Dollars Now – zero risk, cash availability, balance sheet currency debt restrictions
Remain Uncovered - Greatest Risk
-If the dollar depreciates against the Deutschemark greatest Benefit
- If the dollar continues to appreciate- greatest Cost
Full Forward Cover -For the very risk adverse. There is no longer any risk to the ending spot rate.
Partial Forward Cover - Cover part of the total exposure and leave the remaining exposure uncovered. 2nd half is still very sensitive to the dollar appreciating to high amounts t
Foreign Currency Option - The total cost is locked at (DM 3.2/$) 1.6 billion.
Cost + Option Premium (6% - DM 96,000,000)
Buy Dollars now - Obtain the 500 million now and hold those funds in an interest bearing account.
Requires company to have all the money now.
Lufthansa had strict covenants in place limiting the types, amounts, and currency denomiantions of debt it could carry in its balance sheet.

19. Cause and Effect ExchangeRate Economy People Risk level/Constraints
Partial Forward Cover:
3.2DM/$ $250,000
2.2DM/$ $250,000
Risk level/Constraints
Hedging Method

20. Agenda Company Background - Tommy Case Details - Jennifer
Defining the Issues - Luz
Alternative Analysis - Ibrahim
Recommendation - Tommy
Q & A

21. Alternative Analysis

22. Net Cost by Hedging Alternatives
Remain Uncovered
Put Option Cover
Full Forward Cover
Billions of DM
Partial Forward Cover
Ending DM/$ Exchange Rate (Jan 1986)

23. Alternative Analysis
- 900 million variance; too risky

24. Alternative Analysis
- Negates risk; legal obligation; forego favorable movements

25. Alternative Analysis
- Legal obligation; forego favorable movements; uncovered at risk

26. Alternative Analysis
- Flexible; cost ceiling; premium

27. Alternative Analysis
- Limited capital on hand; forego favorable movements

28. Agenda Company Background - Tommy Case Details - Jennifer
Defining the Issues - Luz
Alternative Analysis - Ibrahim
Recommendation - Tommy
Q & A

29. Recommendation CURRENCY OPTION Flexibility – “option to walk away”
Limited downside risk
Maximum total cost is determinable whether exchange rate remains unchanged or increases (1,696,000,000 DM)
Cost difference between a fully uncovered position at a decreasing exchange rate and option is the premium (96,000,000)

30. Recommendation - Implementation
Negate forward contract executed by Ruhnau
Once exchange rate hit 3.3 DM/$, execute sell forward contract
Net money gain $25 million USD (10,869, DM/$)
Purchase currency option for full $500 million USD exposure
Reduce option premium cost to 85,130,435 DM

31. Recommendation – Alternative Solution
Examine the alternative of purchasing planes from Airbus
Airbus is a primary European competitor of Boeing
Bidding war creates leverage for Lufthansa
Highly subsidized by European countries; lower operating costs = lower price
Common currency; no exchange rate risk .
Airbus newer to the game 1958 vs for Boeing
Strategic Alliance of European companies to combat Boeing, McDonnell Douglas, Lockheed
Airbus 320 which competes with Boeing 737

32. THANK YOU
QUESTIONS?