Luftsana Mini Case

Running Head : Transaction Exposure

Currency Risks

Transaction Exposure

[Name of Student]

[Name of University]

In hedging against transaction exposure , upside exposure and downside exposure is defined as the chances that the settlement value , at maturity in terms of home currency , of the obligation due to a counter party or receivable by the company might materially differ from the value expected at the time the transaction was entered into due to the time lag involved . In most un-hedged transactions , downside and upside exposure is unlimited . Forward contracts intend to limit

both exposures by locking in to an agreed upon rate for settlement at an agreed upon maturity date . According to BPP (2008 , This effectively results in a locked in price with no exposure to adverse or favorable market movements and zero uncertainty . However , the opportunity costs of foregoing favorable market movements remains and is the cost that is paid for the certainty emanating from the forward contract (P . 451

In our case question , upside exposure refers to the possible amount that Lufthansa would have gained from a favorable movement in exchange rates with settlement value in DM terms being lower , while downside exposure implies the possible loss made if the transaction had gone unhedged and the settlement value in DM terms being higher . By only hedging half the transaction , the firm ensured that the hedge ratio was only fifty percent with the company exposed (judging by the 1982- 1986 exchange rate graph implying an exchange rate not lower than DM 2...