Group 4

1. Group 4 Jennifer Choi Tommy Fermin Luz Pacheco Ibrahim Shaikh

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

3. 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 China 1934 – first trans-Atlantic flights 1945 to 1955 – air traffic suspended due to war 1960 – enters the jet aircraft age

4. Company Background (cont.) • 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

5. 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

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

7. 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

8. Case Details: X/C Rate Trend DM3.2/$ Jan-85 Sourced by www.oanda.com

9. PPP – U.S low inflation rate made it a good place to invest Inflation Rate US 1980’s • Deregulation - know as “Reagonomics” • Low corporate tax rates & low inflation rates • US Dollar appreciated from 1981-1985.

10. 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

11. 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

12. Case Details: X/C Rate Trend Apr-85 DM2.9/$ Jul-85 DM3.2/$ Jan-85 Sourced www.oanda.com

13. 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

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

15. Defining the Issues

16. Defining the Issues – Exchange Rate Risk • Importance: • Increased cost of doing business • Negative impact to bottom line • Urgency: • Timing is critical • Volatile movement

17. 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

18. 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

19. Cause and Effect ExchangeRate Economy People Partial Forward Cover: 3.2DM/$ $250,000 2.2DM/$ $250,000 Risk level/Constraints Hedging Method

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

21. Alternative Analysis

22. Net Cost by Hedging Alternatives Remain Uncovered Put Option Cover Full Forward Cover Billions of DM Partial Forward Cover Ending DM/$ Exchange Rate (Jan 1986)

23. Alternative Analysis - 900 million variance; too risky

24. Alternative Analysis - Negates risk; legal obligation; forego favorable movements

25. Alternative Analysis - Legal obligation; forego favorable movements; uncovered at risk

26. Alternative Analysis - Flexible; cost ceiling; premium

27. Alternative Analysis - Limited capital on hand; forego favorable movements

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

29. 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)

30. 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

31. 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

32. THANK YOU QUESTIONS?