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Case Summary
The American Institute for Foreign Study (AIFS) is a foreign exchange program organization that provides 50,000 students the opportunity to study abroad. AIFS serve American students traveling abroad to Europe, China, Mexico, and other locations. Therefore, AIFS receive cash inflows in dollars while they pay outflows in mostly Euros and British Pounds. The organization had $200 million in annual revenues. AIFS provides two main divisions: the College division primarily for 5,000 university-aged students and the High School Travel division for chaperoned travel. Lastly, AIFS also offer several over programs such as the Au Pair and Camp America divisions. AIFS protects itself from currency risk by hedging. The company hedges up to two years in advance because it has to be definite before AIFS completes its sales cycle. Therefore there is uncertainty of how much exchange currency the company needed. There was also the concern of how much AIFS should cover of expected cost. Currently, AIFS covered 100%. Lastly, AIFS hedges currency risks through currency forward contracts and currency options. The company wants to operate at a proportion between contracts and options that is most optimal. AIFS guaranteed no price changes before the next catalog. Prices are determined a year in advance. There is uncertainty with hedging. If sales were lower than expected, AIFS may have too much currency and vice versa. Ultimately, the success of hedging depended on the final sales volume and the exchange rate for US dollars. Christopher Archer-Lock, London-based controller and Becky Tabaczynsk, CFO of the high school division are currently debating the use of forwards versus options because of the 100% hedging policy. There are three alternative strategies: no hedging,

100% hedging with forwards, and 100% hedging with options. AIFS also took into consideration of exchange rates of $1.22 USD/EUR, $1.01 USD/EUR, and $1.48 USD/EUR to determine what should be the optimal hedging strategy. Source of underlying risk AIFS faces two different risks; on the one hand side the company doesnt know in advance how many trips it will sell two years from now and on the other hand AIFS sells it trips for a fixe dollar price while it encounters foreign currency (mainly Euro, British Pounds) costs! So the company faces transaction risk in doing international business with some European countries

How to deal with volume risk? The best hedging method is in our opinion using options because if the foreign currencies will depreciate the company will not exercise its options and due to the fact that the costs are relatively small (approx. 5% of all the costs!) and AIFS is in the favorable situation of being able to hand these costs down to the end customer without getting penalized. However, if the company cannot pass on the cost incurred on options (competition is lost likely to copy this strategy), then it must go for optimal mix of futures and options.

Best Hedging Policy? Due to the fact that a company shouldnt speculate but focus on its main business it should hedge only the expected minimum volume or at maximum the average sales volume using future contracts (so AIFS is not exposed to

any FX changes) and should hedge the remaining, above average sale by using option in order to be able to exercise them if favorable to the company.