International FinanceName of the StudentCourseProfessorUniversityDate
International Finance
INTRODUCTION
British Airways is one of the leading airlines in the United Kingdom primarily dealing with vacations and flights internationally. They have several subsidiaries and have increased their fleet to 262 planes. British Airways now has flights to 169 destinations.
Company B: Volkswagen
Volkswagen, Europe’s leading carmaker and one of the most successful global companies, reported a 95 drop in 2003 fourth quarter profits which collapsed from €1.05 billion to a plain €50 million. For all of 2003, Volkswagen’s operating profit fell by 50 percent from the record levels attained in 2002. Although the profit crash had more than one cause, two factors were the focus of much attention – the extraordinary rise in the value of the euro against the dollar during 2003, and Volkswagen’s choice to border only 30 percent of its foreign currency exposure, as opposed to the 70 percent it had traditionally borded. In total, money losses due to the dollar’s rise are projected to have lessened Volkswagen’s working profits by some $1.5 billion.
TRANSACTION EXPOSURE
I have concluded from my analysis that British Airways is mostly affected by the transaction risks. The measurement of this risk helps in the determination of hedging exposure. The differences in the exchange rates directly have an effect on the margin of profits. If these factors are considered to the optimal, the exposure level of the Company can be determined and analyzed to the fullest. There have been developments of varied foreign exchange policies by British Airways to understand hedging needs and instruments.
There cannot be ignorance of pre-transaction exposures as British Airway prices of trading cannot be changed with ease in the global market. This means there is temporary fixing of these rates for a certain time. The profit margins, market value and cash flows are thus affected for British Airways. The measurement of exposure at transactional level will help in the management and maximization of profits, cash flows and value in the market (KEVIN, 2009).
As for the case of Volkswagen, I think that the fluctuation in cash flows as a result of Company lag in the address of risks of foreign exchange has created operating problems for the entity. Here, the profits have been cut off and there is reduced entry of the cash flows and there is dropping of value of the firm. The dropping of market value in the firm will result in high levels of loss for Volkswagen in amounts of both value and capital. The transaction exposure for Volkswagen is not as much as the operating risk.
OPERATING EXPOSURE
As per my study, Operating exposure cannot be determined from Volkswagen’s accounting statements as can transaction exposure. Their operating exposure is determined by the market structure of inputs and products, how competitive or how monopolistic the markets are facing Volkswagen. Their ability to adjust the markets, product mix, and sourcing in response to exchange rate changes .
In 2013, Euro appreciated against US dollars. Volkswagen decreased their profit by 90% in 2003 fourth quarter. The revenue Volkswagen received was worth less than the years before, the US dollar is not powerful. There was a big loss by the currency risk .
The Volkswagen company’s exposure of interest rate fluctuation and the foreign exchange fluctuations can be categorized as transaction or operation exposure having a very high risk. The impulsiveness in the dollar value across the countries involved in foreign trade is a chief issue in disturbing or affecting the trade. The company must determine the best possible way to diminish the risks to operate successfully. Handling of these kinds of risks is costly and takes up a great deal of time. These exposures must be managed to lessen the effects of the fluctuations in the forex market on the profit margins of the company and assist in the product pricing that are sold on the foreign or the international markets. Risks arising from the transaction and operating exposure can be condensed at a sensible and appropriate cost since the majority of the risk that arise from the foreign operation or the operation in the global market are almost impossible to avoid.
Economic exposure is also a threat to British Airways. This is because of the variations in the project values that stem from the variation in the exchange rates that were least expected in the Company. The financing of the reports is also equally affected by the movements of rate of exchange which is known as the translational exposure for British Airways. Contingent exposures have also been identified which comprises of a combination of transactional as well as economic exposures for a number of contracts and negotiations undertaken.
SIMILARITIES:
The similarity of the exposure risks for both the Companies could be that both function across many nations and thus the problem of transaction and operating risks is highly significant. Another important similarity could be the currencies that they need to deal with at the exposure levels.
DIFFERENCES:
The differences could be the nature of currencies and the volume of currency collected. It is because British Airways needs to maintain a higher level of diversity given that it is a service and needs to maintain payment terms and clauses essentially in all languages. The continuity and intensity of both exposures may also vary.
F. METHODS/ TOOLS USED:
Companies that have extended its operations in the foreign markets or the companies that deal with foreign transaction or have the impacts of the fluctuations in the forex market require management to find ways to manage and handle the exposure. This is in order for the company to be successful. British Airways uses the process of risk management and put all contracts in a foreign language. The variations in the rate of exchanges directly affect the profit margins. This requires management to implement policies and strategies that will ensure the risk is reduced of eased to keep the expected profits and cash flows. These transactions require high capitalization in investments.
British Airways has problems with their revenue and currency, which exposes them to currency risk on revenue. The currencies they receive come in the US dollar, euro, and Japanese yen. They receive profit with the euro and Japanese yen. However, the US dollar creates a deficit for them . British Airways had an opposition that came on how they handled their foreign exchange. They looked for ways to lessen the exposures by making sure the policies, receipts and payments matched the particular currencies .
The foreign currency risk of Volkswagen is limited through natural hedging. They establish their new production facilites in locations whose currency they deal with. The hedging instruments used by Volkswagen are currency forward, currency options and cross currency swaps. They use this method to limit the risk associated with forecasted cash flows. This method is used to hedge Volkswagen’s foreign currency risk and against the currency in certain countries. .
Volkswagen diversifies when investing extra solidity and by entering into financial gadgets for hedging reasons, it is confirmed that the Volkswagen Group remains funded at all times, even in the result of a failure to pay by individual counterparties .
Volkswagen ensures that they have funds available all the time. They do this with approved credit lines and capital markets. In order to protect the capital investments of financial amenities, they obtain funds for the maturities in the international financial markets. They also depend on customer deposits from the direct banking business .
G. CRITICAL EVALUATION:
According to my assessment, the strategies used by Volkswagen are more mature and effective in exposure deterrence as compared to that of British Airways. The strategies used by the Companies are good in their own light. I personally believe that being multinational organizations, the management of these risks could have been better.
The operational strategies that I believe should be focused by Volkswagen for better could be:
The diversification of production facilities and finding market products should be focused. The mitigation of risks in production facilities could be possible with this technique.
Alternative sources in regards of key inputs should be prioritized. It helps regionalizing expensiveness of inputs.
There should be access of capital in major markets where the Companies operate.
I believe that the currency risk mitigation strategies would be more beneficial for British Airways (Volkswagen has been using some of these strategies) could be:
The matching of currency flows should help companies borrow and adjust in foreign currency.
Agreements should be set with regards to risk sharing of currencies so that risk can be minimized through sharing of fluctuation risks. A price adjustment clause is needed.
Swapping of currencies could also be one of the ways for both the parties to get the best of rates in the market.
As per my analysis, for the exposure management, the following chart may be beneficial.
I strongly recommend that British Airways and Volkswagen need to go past financial management with good strategic planning. The most important factor is putting good assets in different locations to keep their future survival from being affected by changes (International Business, 2007).
I also think that there are different ways that these companies can take care of their cash in the short term. Some of the ways are buying swaps, using lead strategy and collecting their receivables if the exchange depreciates. In my analysis, British Airways and Volkswagen must realize that there must a control of the exposures to protect their assets. They must make the difference between the three types of exposures. Also, their accounting reporting systems must be on point so they can be looked at carefully (International Business, 2007).
I believe that internal strategies such as leading and lagging can ensure that firms use exchange rate movements to ensure that they always pay less and earn more. Leading is paying or collecting in advance. Lagging is basically late payments. These payments can be late or early; it really does not matter.
Conclusion
The foreign exchange market is an important factor in trading and investing globally. British Airways and Volkswagen need to be able to trade in different currencies .
Bibliography
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Covriq, V. Management of Economic Exposure. California State University.
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International Business (6th Edition ed.). (2007). Irwin: McGraw Hill.
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Prezi. (n.d.). Volkswagen's Hedging Strategy. Retrieved May 3, 2016, from https://prezi.com/09wxcj-a-fk4/volkswagens-hedging-strategy/
Volkswagen. (2014). Strategies for hedging financial risks. Retrieved May 3, 2016, from http://annualreport2014.volkswagenag.com/group-management-report/report-on-risks-and-opportunities/risks-and-opportunities/financial-risks.html
