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Group 4

Jennifer ChoiTommy Fermin

Luz PachecoIbrahim Shaikh

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Agenda

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

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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 China1934 – first trans-Atlantic flights1945 to 1955 – air traffic suspended due to war1960 – enters the jet aircraft age

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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

Company Background (cont.)

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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

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Agenda

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

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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

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Case Details: X/C Rate Trend

DM3.2/$DM3.2/$Jan-85Jan-85

Sourced by www.oanda.com

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Inflation Rate US 1980’s

PPP – U.S low inflation rate made it a good place to invest

Deregulation - know as “Reagonomics” Low corporate tax rates & low inflation rates US Dollar appreciated from 1981-1985.

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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

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Case Details - Outcome $250 million forward contract @ 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

USD DM1985 Forward Contract (3.2 DM/$) 250,000,000 800,000,000 1986 Spot Rate ( 2.3 DM/$) 250,000,000 575,000,000

Total Cost 1,375,000,000

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Case Details: X/C Rate Trend

0

0.5

1

1.5

2

2.5

3

3.5

DM/$

DM3.2/$DM3.2/$Jan-85Jan-85

Apr-85

Sourced www.oanda.com

DM2.9/$Jul-85

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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

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Agenda

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

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Defining the Issues

Importance

Urgency

Low High

Low Forecast Exchange Rate

Financial Health of Company/Shareholders

High Type of Planes IV

Exchange Rate Risk

Hedging Method

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Defining the Issues – Exchange Rate Risk

Importance: Increased cost of doing business

Negative impact to bottom line

Urgency: Timing is critical

Volatile movement

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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

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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

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Cause and Effect

Risk level/Constraints

Partial Forward Cover:

3.2DM/$ $250,000

2.2DM/$ $250,000

Economy People

Hedging Method

ExchangeRate

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Agenda

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

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Alternative AnalysisALTERNATIVE

Scenario Total Cost Risk1) Remain Uncovered A $500 million @ 2.2 DM 1,100,000,000 HIGH

B $500 million @ 4.0 DM 2,000,000,000

2) Full Forward Cover A $500 million @ 3.2 DM 1,600,000,000 LOW

3) Partial Forward Cover A $250 million @ 3.2$250 million @ 2.2 1,350,000,000 MEDIUM

B $250 million @ 3.2$250 million @ 4.0 1,800,000,000

4) Foreign Currency Option/Put Option A $500 million @ 3.2 + 6% premium 1,696,000,000 LOWB $500 million @ 2.2 + 6% premium 1,196,000,000 C $500 million @ 4.0 + 6% premium 1,696,000,000

5) Buy Dollars Now/ Money Market A $500 million @ 3.2 1,600,000,000 N/A

DECISION CRITERIA

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Net Cost by Hedging Alternatives

1.00

1.20

1.40

1.60

1.80

2.00

2.20

2.20 2.40 2.60 2.80 3.00 3.20 3.40 3.60 3.80 4.00

Remain Uncovered

Full Forward CoverPut Option Cover

Partial Forward Cover

Billions of D

M

Ending DM/$ Exchange Rate (Jan 1986)

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Alternative AnalysisALTERNATIVE

Scenario Total Cost Risk1) Remain Uncovered A $500 million @ 2.2 DM 1,100,000,000 HIGH

B $500 million @ 4.0 DM 2,000,000,000

2) Full Forward Cover A $500 million @ 3.2 DM 1,600,000,000 LOW

3) Partial Forward Cover A $250 million @ 3.2$250 million @ 2.2 1,350,000,000 MEDIUM

B $250 million @ 3.2$250 million @ 4.0 1,800,000,000

4) Foreign Currency Option/Put Option A $500 million @ 3.2 + 6% premium 1,696,000,000 LOWB $500 million @ 2.2 + 6% premium 1,196,000,000 C $500 million @ 4.0 + 6% premium 1,696,000,000

5) Buy Dollars Now/ Money Market A $500 million @ 3.2 1,600,000,000 N/A

DECISION CRITERIA

- 900 million variance; too risky

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Alternative AnalysisALTERNATIVE

Scenario Total Cost Risk1) Remain Uncovered A $500 million @ 2.2 DM 1,100,000,000 HIGH

B $500 million @ 4.0 DM 2,000,000,000

2) Full Forward Cover A $500 million @ 3.2 DM 1,600,000,000 LOW

3) Partial Forward Cover A $250 million @ 3.2$250 million @ 2.2 1,350,000,000 MEDIUM

B $250 million @ 3.2$250 million @ 4.0 1,800,000,000

4) Foreign Currency Option/Put Option A $500 million @ 3.2 + 6% premium 1,696,000,000 LOWB $500 million @ 2.2 + 6% premium 1,196,000,000 C $500 million @ 4.0 + 6% premium 1,696,000,000

5) Buy Dollars Now/ Money Market A $500 million @ 3.2 1,600,000,000 N/A

DECISION CRITERIA

- Negates risk; legal obligation; forego favorable movements

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Alternative AnalysisALTERNATIVE

Scenario Total Cost Risk1) Remain Uncovered A $500 million @ 2.2 DM 1,100,000,000 HIGH

B $500 million @ 4.0 DM 2,000,000,000

2) Full Forward Cover A $500 million @ 3.2 DM 1,600,000,000 LOW

3) Partial Forward Cover A $250 million @ 3.2$250 million @ 2.2 1,350,000,000 MEDIUM

B $250 million @ 3.2$250 million @ 4.0 1,800,000,000

4) Foreign Currency Option/Put Option A $500 million @ 3.2 + 6% premium 1,696,000,000 LOWB $500 million @ 2.2 + 6% premium 1,196,000,000 C $500 million @ 4.0 + 6% premium 1,696,000,000

5) Buy Dollars Now/ Money Market A $500 million @ 3.2 1,600,000,000 N/A

DECISION CRITERIA

- Legal obligation; forego favorable movements; uncovered at risk

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Alternative Analysis ALTERNATIVE

Scenario Total Cost Risk1) Remain Uncovered A $500 million @ 2.2 DM 1,100,000,000 HIGH

B $500 million @ 4.0 DM 2,000,000,000

2) Full Forward Cover A $500 million @ 3.2 DM 1,600,000,000 LOW

3) Partial Forward Cover A $250 million @ 3.2$250 million @ 2.2 1,350,000,000 MEDIUM

B $250 million @ 3.2$250 million @ 4.0 1,800,000,000

4) Foreign Currency Option/Put Option A $500 million @ 3.2 + 6% premium 1,696,000,000 LOWB $500 million @ 2.2 + 6% premium 1,196,000,000 C $500 million @ 4.0 + 6% premium 1,696,000,000

5) Buy Dollars Now/ Money Market A $500 million @ 3.2 1,600,000,000 N/A

DECISION CRITERIA

- Flexible; cost ceiling; premium

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Alternative AnalysisALTERNATIVE

Scenario Total Cost Risk1) Remain Uncovered A $500 million @ 2.2 DM 1,100,000,000 HIGH

B $500 million @ 4.0 DM 2,000,000,000

2) Full Forward Cover A $500 million @ 3.2 DM 1,600,000,000 LOW

3) Partial Forward Cover A $250 million @ 3.2$250 million @ 2.2 1,350,000,000 MEDIUM

B $250 million @ 3.2$250 million @ 4.0 1,800,000,000

4) Foreign Currency Option/Put Option A $500 million @ 3.2 + 6% premium 1,696,000,000 LOWB $500 million @ 2.2 + 6% premium 1,196,000,000 C $500 million @ 4.0 + 6% premium 1,696,000,000

5) Buy Dollars Now/ Money Market A $500 million @ 3.2 1,600,000,000 N/A

DECISION CRITERIA

- Limited capital on hand; forego favorable movements

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Agenda

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

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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)

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Recommendation - Implementation Negate forward contract executed by Ruhnau

Once exchange rate hit 3.3 DM/$, execute sell forward contract

Net money gain $25 million USD (10,869,565 DM @ 2.3 DM/$)

Purchase currency option for full $500 million USD exposure Reduce option premium cost to 85,130,435 DM

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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 320 which competes with Boeing 737

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QUESTIONS?

THANK YOU