Advising Boeing And Airbus On Foreign Exchange Risk Finance Essay

Advising Boeing And Airbus On Foreign Exchange Risk Finance EssayBOEING Boeing is the worlds largest aerospace confederacy. Being a leading manufacturing business of moneymaking(prenominal) jetliners, it is a top US exporter. It provides tailored services that include commercial and military aircraft, satellites, weapons, electronic and defense systems, launch systems, advanced information and confabulation systems. (Boeing, 2010). The company has it corpo commit offices in Chicago and in addition employs more than 159,000 people across the fall in States and in 70 countries, also has nearly 12000 commercial jetliners, in service worldwide, which is roughly 75 percent of the world fleet. (Boeing, 2010).AIRBUS Airbus is a leading aircraft manufacturer owned by European Aeronautic Defense and Space lodge (EADs), a global leader in aerospace defense and related services. Having its headquarters in Toulouse, France, it has fully owned subsidiaries in the United States, China, Japan and Middle East. It has it fifth wheel part centers in Hamburg, Frankfurt, Washington, Beijing and Singapore, training centers in Toulouse, Miami, Hamburg, and Beijing (Airbus, 2011). The company has 150 field service offices around the world and employs a total course force of 119,000 and has presence on every continent (Airbus, 2011).The major competitor of Airbus is Boeing fellowship.FOREIGN EXCHANGE RISK Foreign exchange happen is defined as the risk that an investor will have to close out a long or short position, in a strange capital at a loss due to an adverse movement in exchange rates. It is also known as currency risk or exchange-rate risk. (Investopedia, 2010). Simply put it is the erect that fluctuations in foreign currencies or exchange rates that affect the business entity.It is evident that large corporations like Boeing and Airbus that have operations in many countries ar exposed to foreign exchange risks. It importantly arises due to difference in the curre ncies in which the company bears its operating or production be and the currency in which the company receives compensations from its clients.Boeing being a US company, it proclaims its financial proceeding in US dollars. The input output is priced in US dollar which is a globally accepted currency. So even if it does trading in some a nonher(prenominal) countries, it receives payments in US dollars. Hence it is exposed to low forex risk. Airbus being a French company, it reports its exercises in Euros. Input or output is been priced in Euro in the domestic market, while in the world market is been priced in dollar which is globally satisfying currency and this exposes the company to high forex risk be realize Euro is not a global currency.We summarize it through following tableCompany specie of CostsCurrency of RevenueMatch/ twinBoeingUS DollarUS DollarMatch between currencies.AirbusEurosUS Dollar (assume 60%)Euros (assume 25%)Others (assume 15%)Mismatch of currencies.T YPES OF EXPOSURESTRANSACTION EXPOSURE Transaction exposure measures changes in the value of financial obligations incurred before a change in exchange rates but to be settled after the change.(Hagelin, 2003). It is the risk of changes in exchange rates between the time that a good is sold and the time that payment is received in foreign currency.For Airbus As explained above the currency costs of Airbus are in Euros while cost of revenues is mostly in US dollars and some in Euros. This mismatch is clear from the annual report of the company according to which the operations of the group are mainly concentrated in different countries such as China, United States, India and Middle East hence the payments are done in US dollars. This explains that Airbus has a high transaction exposure towards US dollar. Any fluctuations in the rate of US dollar against the Euro would affect the profit margin of the group. The long term contracts that must be honored at future rates are the other cause s of transaction risk to the Euro. Though sometime the profits are being locked in by using long term contracts for e.g. for spare parts, on that point is an luck cost involves as the value of Euro or the price of commodities may amplification. (Chester Chronicle, 2008)For Boeing The cost of revenues as well as production, are denoted in US Dollars. Hence there is a perfect match. So even if the company has operations in many parts of the world such as Australia, Canada, China, India, Italy, Japan, Russia, and UK, the transaction exposure is less. even if there is dissimilarity in the currency when Boeing sells its product to the different countries, the value is adjusted depending upon the countrys currency. The exposure arises due to variation in the currency rate, mainly of US dollar with other currencies. The danger here would be that the currency of the other country may strengthen or weaken to the corresponding US dollar. (Kascey, 2011). witness the USD depreciates by 30%. The US currency would be under-valued, so this would lessen the profit margin of Boeing from payments received. But it would also reduce its cost of production. Thus this would hugely benefit for Boeing. On the other hand it would be very problematic for Airbus, as it would affect only the revenues and not the production costs. The decreased profits would cause a huge problem for Airbus.However, if USD value appreciates 30%, it would be of tremendous benefit to Airbus as the profits would be enhanced because of overvalued US dollars. Boeing would have to human face the problems of gaind cost of production but they would be backed off by the fact that payments would also be received in appreciated currency. displacement reaction EXPOSURE It is the risk that when the results of foreign subsidiaries are consolidated into the parents currency, translational gains or losses will result between reporting dates. The effects of translation risk are normally seen in the income statement a nd balance sheet.For Airbus It deals mainly in aerospace, defense and commercial services. The Airbus commercial contributes 59% to the Companys revenue in 2009. (Airbus Annual report, 2009)The Company has a huge translation exposure, owing to the fact that it reports its earning in Euros. Transactions of its foreign subsidiaries, in foreign currencies other than the Euro are translated into Euro at the prevailing foreign exchange rate as at transaction date. It is mainly to the US Dollar as the trading in the industry and international markets is basically in US Dollar while the company reports its earnings in Euros.The translation risk of the company is evident in 2008 when the company had a decrease of 1% in revenue of 43.265 million due to an unfavorable impact of the US Dollars. Furthermore, in 2007, their chairman- Mr. Louis Gallois in his estimation said every Euro appreciation of 10 cents against the USD is a cost of 1B to the company based on the fact that Airbus costs are denominated in Euros while the major share of its revenues are in USD. Airbus also holds a substantial US Dollar denominated assets that are subjected to translation risk. (http// outsmartcurrencyrisk.com/36/foreign-exchange-risk-can-be-huge-fortunately-it-can-be- handled/).For Boeing It deals in commercial and military aircraft, satellites, weapons, electronic and defense systems, launch systems, performance based logistics and training. Of this, commercial airplanes contribute 49.8% of the companys revenues (Boeing Annual report, 2009).Boeing does not have any translational exposure. This is only because the companys trading in international markets is mainly in US Dollars and the company reports financial data in US Dollars only.ECONOMIC EXPOSURE It is the change in the net present value of future cash flows of the firm as a result of unanticipated changes in real exchange rates. It gives an idea of the potential volatility of the company.For Airbus Economic exposure of the compa ny is substantially important due to the geographical locations of companys operations. The operating costs are mainly in the Euros and in some other currencies in small portions. The earnings are in US dollars in majority. So if the Euro depreciates by 30% against the USD, its operating costs would relatively go down and it would gain cost advantage. Also its reported profits in Euros would increase due to exchange rate. And if the Euro appreciates by 30% against the USD, it will be facing a huge economic exposure as the operating costs would increase substantially and the reported earnings in Euros would also be less.For Boeing With 82% of the employees of the company based in America and remaining 18% employees in other locations like India, New Zealand etc, majority of operating costs are in US dollars. So Boeing Company would pay employees mainly in USD while a little portion in other currencies also. The Boeing Company receives its revenue in USD only. Because of this match, any increase or decrease in USD would accordingly increase or decrease twain the operating costs as well as profits. Hence the exposure is small and easily manageable, as they are already in USD denomination.COMPARISON CHART From the above explanation, the exposures of the 2 companies can be summarized by the following tableCompanyTransactionTranslationEconomicBoeingSmall free to manageDoes not exist.Small but bedableAirbusBig Very Difficult to manageHigh Difficult to manage.Huge. Very difficult to manage intrinsic HEDGING Internal hedging means using proficiencys available within the company or group to manage exchange rate risk. These techniques do not operate through the foreign exchange market and therefore they avoid associated costs. However, this does not mean they are costless.INTERNAL HEDGING TECHNIQUESMATCHING RECEIVABLES AND PAYABLES There is no problem if the receivables and payables are in the same currency. If the receivables and payables are in different curren cies (mismatch) then there is a risk involved in it. (Joseph, 2000).Airbus operations in US would insulate its risks, as the cost of operations in USD is matched by payment in USD gained from various services and selling various products in US itself. Fluctuations in other currencies will be negligible as the company will not have to pay operating costs in USD with Euro. In dress to provide insulation towards risk in various other countries Airbus can obtain revenue in domestic currencies to pay operating costs in different currencies, payables and receivables for example. As a result of this economic risk can be minimized. (Joseph, 2000) However, this matching of receivables and payables will succeed only to a original extent. As Airbus would have to borrow Euros with the currency received from other countries in order to bear the operating costs in its own parent company- France.In face of Boeing, this is not required as the company already has a perfect match between the curre ncies of its trade receivables and payables.CENTRALIZED AND DECENTRALIZED TREASURY work out (MULTILATERAL NETTING) Airbus with its centralized treasury function utilizes multilateral gain, which is one of the forms of intimate hedging against foreign exchange exposure, in order to reduce risk.Multilateral netting is tack together commonly in Enterprise Wide Risk Management (EWRM) where the parent companys subsidiaries would report the forecasted payments and receipts in the foreign currencies and estimated current exposures to them. After taking internal hedging into account the central treasury calculates the net exposure of the company towards each currency. And it makes use of external hedging to hedge residual exposures. In order to have exchange controls as well as clear understanding of taxation in their respective countries multilateral netting requires subsidiaries of the group to have a standardized budget reporting periods. The savings gained through the implementation of EWRM information system are also important and are enough for the cost to offset. (Aucoin, 1990).The main advantage of EWRM also includes reducing the capital costs by managing the volatility of earnings. This is made possible through internal rate risk and external hedge of dangerous exposures towards foreign exchange. ERM maximizes the portfolio effect and even helps organizations to exploit natural hedges as stated in capital asset pricing model. (Aucoin, 1990).Hence multilateral netting is applicable to Boeing. As multilateral netting is most commonly found in EWRM, by managing the volatility of earnings it reduces the capital costs. Thereby the risk of Boeing is also reduce.CURRENCY OF INVOICING The choice of currency which international trade is invoiced is of high implication for Airbus and Boeing due to the nature of their products and services. In trying to avoid foreign exchange risks, both companies adopt currency of invoicing by choosing which currency to be used in international trade. The strategy would be helpful to both companies only when properly planned. demand Boeing just got a contract with British airways to build five 747s and one is to be delivered each year for the next 5 years. We assume the rate to be 10 million per plane. If Boeing can negotiate and adjust the terms of the invoice, it can shift, share or diversify the currency risk involved in this transaction which would be an added advantage to the company.To transfer the risk, Boeing can invoice the transaction in USD, then it has eliminated currency risk for itself, however, it has shifted it to British Airways. Assume $ =$1.80, then British Airways has an $18 million account payables and Boeing has an $18 million account receivables.To share the currency risk between both companies, British Airways can share the risk by invoicing 50% of the transaction in USD and the other 50% in British Pound (BP), i.e. $7.5m +5m for each planes.The risk can even also be reduced by diversi fication through the payment of the transaction in various currencies based on the negotiation between the two companies. By so doing, Boeing has managed the currency risk.Airbus in similar situation can do the same but this time the currency involved will be Euro and British Pounds or some(prenominal) other currencies in case of diversification. (http//spruce.flint.umich.edu/mjperry/466-13.htm).ASSET AND LIABILITY MANAGEMENT Asset and liability management (ALM) is basically a technique of risk management designed so as to earn an adequate return while maintaining a comfortable surplus of assets beyond liabilities. Boeing and Airbus do use this risk management technique to address foreign exchange risk and even operational risk and it also includes hedging where they can hedge against movements in fuel prices.Boeing and Airbus can manage their asset and liability in such a way as toIncrease their overall earningsEnsure efficient use of their capital and assetsManage the associated risk in a cost effective way. (http//www.investorwords.com/285/asset_liability_management.html).LEADING AND LAGGING Leading is an internal hedging technique that is the acceleration of payment of companys obligation (e.g., payment to suppliers) before the due date while lagging, also internal hedging techniques, is the delay of payment of a companys obligation past its due date. (http//www.angelfire.com/ca/finrisk/Leading.html)For example, when Airbus or Boeing expects the currency (Euro) or (USD) respectively to appreciate in value, they may accelerate (leading) this obliged payment and realize the payment before the currency appreciates. In the same manner, when the value of the currency is expected to decrease in value, they may delay (lagging) payments so as not to make a loss in the transaction. (Victor P and Yann S, 2003).CONCLUSIONIn conclusion, we say that Foreign Exchange Risks depend upon the currency of costs and currency of revenues. Any difference within them is going t o expose the company to Forex risks. The Forex risk that BOEING is exposed to is less mainly owing to the match between its input and output pricing currencies. While AIRBUS is exposed to huge risks as there is variation in the currencies of its costs and revenues. Also BOEING has Maintenance Contracts with companies and contracts with its Government to supply Military Planes due to which its risks have a backup from their Government in case of Financial Crisis. However AIRBUS doesnt have any such backing from its Government. This coupled with the high risks that it is exposed to pose a grave threat for the company in case of financial crisis. The Internal Hedging mentioned above though useful for the companies are subjected to their effective and timely. And Airbus would be better naturally hedged against the risks by converting to report its financial transactions in US dollars than Euros.