1. Lufthansa Case Study

2. Synopsis • Lufthansa, purchased twenty 737 Boeing aircraft in January of 1985 for $500 million. • The payment was due in January of 1986 upon delivery of the aircraft from the U.S. manufacturer. • At the time of the purchase, the U.S. dollar was at a record high versus the Deutschemark, and had been steadily appreciating against the Deutschemark for 5 years. • The CEO of Lufthansa, Herr Heinz Ruhnau, was responsible for determining what hedging if any would be use.

3. Focus of The Case • The focal point of of this case is the managerial decision-making, the formation of expectations, and the value and leadership of senior management. • Arguing over what Herr Heinz Ruhnau did in retrospect and what we may think he should have done is not the point. • The more general lesson is whether the firms best interests are found in accepting open uncovered positions or not.

4. Question 1 • T dollar was “high” at this point, and therefore the decision to purchase now seems to be a bit late. • Yet, given the trend in the movement of the DM/$ rate over the previous years, it appears (using the graphic available to Herr Heinz Ruhnau in January 1985, Exhibit 2), that postponing the purchase would only result in a higher dollar and therefore a higher expense.

5. Question 2 • Should Herr Ruhnau have gone “whole hog”? • There are two views • Since he is paid the big bucks to make the big decisions, and if he believed the dollar was about to fall he should have remained completely uncovered. • Or, on the contrary, he is also paid the big bucks to pursue Lufthansa’s strategic future, and that does not include the gambling on exchange rate movements. • Both views are valid, however, that the 50/50 result is difficult to defend itself. • (This is equivalent to covering one exposure and leaving an identical exposure completely uncovered; a somewhat schizophrenic “view” on the direction of exchange rate movements.)

6. Question 3 • The purchase of a put option would have indeed provided solid insurance. Yet, it is difficult to explain why one should spend millions on the purchase of protection which one hopes not to use. • This is a flawed argument as it is obvious if we extend it to any insurance policy. However, it has real meaning in many boardrooms even today. • As a matter of fact, few private firms were actually using currency options for risk management in 1985 when this situation arose. • Herr Ruhnau could have purchased an out-of-the-money put option on Deutschemarks to reduce the premium paid. • He could also have purchased a collar, i.e., sold a call to finance the purchase of the put option hedge on Deutschemarks to reduce the premium further.

7. Question4 • 4. Why Boeing instead of Airbus? • We have no information for a factual evaluation of this issue. • But it is important to notice that the choice of purchase and the terms of a purchase give rise to the exposure itself.

8. Other Points • The initial decision is made with a highly overvalued dollar but a trend line which was hard to argue with. What do you expect, and which hedging alternative would you pick? • With the 50/50 hedge position he cannot possibly win. One side’s gains will always offset the losses on the other. • Why did Ruhnau not change his position when it became clear that the dollar had indeed peaked and was on its way back down? • This may be the most legitimate criticism of Herr Ruhnau’s management: the failure to re-position the hedge when new information is incontrovertible. Although this would not recoup previous exchange rate losses, it would allow Lufthansa to enjoy any further drop in the value of the dollar (or suffer any increases if the value of the dollar turned once again).