CEU Electronic Theses and Dissertations, 2020
| Author | Majeed, Imran |
|---|---|
| Title | Hedging Strategy to Minimize the Impact of Transactional Risk Associated to Forex |
| Summary | GECAS (GE Capital Aviation Services) is an American commercial aviation financing and leasing company. The company offers many aviation finance services, including aircraft leasing, aircraft lending, engine leasing, asset management, and aircraft consulting. In terms of aircraft leasing, GECAS purchases aircraft from manufacturers such as Airbus and Boeing, and then leases them to airlines, typically for about eight years, and usually on dry lease contracts. Due to the fact that the company is US based and its functional currency is USD, a considerable portion of the business which comes from non-US countries causes severe exposure of risk from foreign exchange volatility. The situation was well explained by taking an example of a lease contract worth €10,000,000.00 with a client based in Europe in January 2017. The inter-bank exchange rate of Euro to the US dollar at the time of the transaction was EUR/USD 1.3169. Settlement for this transaction was to be made over a period of twenty four months. If the European company pays Euro to GECAS, the amount payable at the time of the transaction would be approximately USD 13,169,000.00. But because the lease contract was for the duration of twenty four months, it required the amount to be split into twenty four equal installments, starting from January 2017 till December 2018. Due to volatility in EUR/USD pair currency, the company ended up receiving USD 11,959416.67 which means FX loss of 9% to the company’s revenue. A detailed analysis on currencies was also taken place to come up to a decision whether which currency to hedge and which should not to be hedged. After analyzing the business proportion of the main currencies, its cost for hedging and its volatility to the pair currency it was concluded that Euro is the main currency which is to be hedged primarily. Following to deciding which currency to hedge, a strategy was proposed to the company based on a financial instrument Currency Swap. According to the methodology of the strategy, GECAS can enter into a contract of floating to fixed coupon only currency swap with a bank in order to hedge against the volatility of the currency. In this hedging mechanism, the company will pay coupon payment based on floating rate of the currency to the bank and receive coupon payment based on fixed rate of the currency from the bank. The term coupon only means that both counter party do not require to exchange principal amount in the end of the contract, though the coupons would be calculated as per the agreed principal amount. The same methodology was applied to the example in order to observe the mechanism and its ending result. After drafting the strategy in numbers and preparing it a table we were able to observe the elimination of transactional volatility from the cashflow which the company received over the period of twenty four months. |
| Supervisor | Szilagyi, Peter |
| Department | Economics MSc |
| Full text | https://www.etd.ceu.edu/2020/majeed_imran.pdf |
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