Q1. What gives rise to the currency exposure at AIFS?
* Currency exposure is the extent to which the future cash flows of an enterprise, arising from domestic and foreign currency denominated transactions involving assets and liabilities, and generating revenues and expenses, are susceptible to variations in foreign currency exchange rates. * AIFS organizes educational and cultural exchange programs throughout the world. AIFS receives most of its currencies in American dollars (USD but it incurs costs in other currencies mainly in Euros (EUR) and Pounds (GBP). * AIFS hedged its future cost commitments up to 2 years in advance. The problem was that the hedge had to be put
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If AIFS uses forward contract the gain is larger compared to when it uses options contract because the options contract costs 5% of the nominal USD strike price. * In square 3 the exchange rate moved out of money (1.01USD/EUR) and the sales go higher (30000) than expected. So AIFS doesn’t have to buy euro at higher rate, therefore, the Options contract is better, as the extra volume they need (5000), can be bought at the spot rate. The increase of the Spot and Fixed rates and the difference of the volume of sales are the reason for company loss. * The tricky square 4 shows when the exchange rate moved in the money (1.48 USD/EUR) and AIFS’s sales volume came in higher (30000) than projections, which means the company need more currency (5000), however, the exchange rate is high. In this case, Forward contracts should be used and the extra volume at the spot rates should be bought. The increase of sales may offset the downside. * For companies that work with more than one currency, several hedging techniques are available to guard against foreign exchange fluctuations. After studying and addressing the case study of AIFS, it can be concluded that the changes in fees can be the cause to currency exposure. The fact that the company’s revenues are in USD, and costs in GBP and Euro’s may result in a rise to