FX risk hedging at EADS 1 2 Reasons for EADS FX risk management - PowerPoint PPT Presentation

FX risk hedging at EADS 1

2 Reasons for EADS FX risk management policy Reasons for EADS FX risk management policy Mismatch between dollar denominated revenues and euro, pounds 1 denominated cost base ( 50 % of aircraft’s order) Significant time lapse between payment commitment and cash receipt 2 ( about 8 years) Loss of competitiveness as prime rival (Boeing) is a US-based 3 manufacturer Loss of competitiveness (Prime rival is a US- based manufacturer) Large amount of eligible exposure with highly instable exchange rates have a 4 dramatic impact on company’s EBIT

Double - pronged approach 3 Double – pronged approach Restructuring Programs (e.g. Power8) Risk mitigation (natural hedge) Using off- shores Double- pronged approach Hedging with forward contracts Risk transfer Hedging with options

What is the Speed Grid ? 4 What is the Speed Grid ? Speed grid is a mechanical hedging approach that is aimed to determine the weekly amounts of FX forward contracts to purchase in order to execute EADS’ hedging policy.

5 5 Factors affecting speed of hedging Factors affecting speed of hedging Year to hedge Hedging Speed Result Dollar to euro forward Execution EADS’ hedging the further ahead, the less is The weekly amounts of FX exchange rate, hedged per week forward contracts to policy the stronger the forward purchase exchange rate for the dollar against the euro, the higher weekly amounts of forward contracts that traders had to purchase and vice versa.

6 The pros and cons of Speed Grid The pros and cons of Speed Grid In extreme cases the Speed Grid’s functioning is not appropriate to EADS’ FX hedging policy.

7 At a crossroads At a crossroads Resetting Speed Grid: Increasing the amount hedged per week Hedging with a large single forward contract: All the eligible exposure will be hedged within a month by using forward contracts Using FX options: EADS Front Office can decide is it worth to be exercised or not

8 Current Business Environment Current Business Environment Drop in Exchange Rate Increase in Current Business Environment from $1.20/ € to $1.47/ € two Number of years later Aircrafts Orders Growth of Euro Decrease in earnings 1 1 denominated cost base Growth of credit Growth of delivery years spread volatility risk ahead up to 8 years Surge in Overall dollar Decline in the share 2 2 price from € 21.8 to exposure up to $94.2 € 15 per share billion

Comparison of options and forward contracts 9 Comparison of options and forward contracts FX Options Requirement of Flexibility mark-to-market through P&L Risk mitigation in volatile Huge expenses on option premium, market especially in volatile market (2-8% of the contract ) Elimination of default risk Option for reselling Rumors on the market Gaining counterparty’s loyalty Forward Contracts Relatively cheap instrument Strict obligation

10 Alternatives Evaluation Alternatives Evaluation The aim of the analysis: Data Time period to find out which alternative’s weekly spot and forward exchange rate could be the most EURO/USD exchange rates beneficial To From weekly central strike prices of EURO/USD options 2000 March of 2008 weekly premiums of EURO/USD options Source: Bloomberg

11 Alternatives Evaluation Alternatives Evaluation Time FX exposure distribution FX exposure, Share in total Period 0,7% 1,3% bln. $ FX exposure 1 year 5,1% Current year 0 0,0% 2 years 6,6% In 1 year 326 0,7% 3 years 32,5% 8,0% In 2 years 661 1,3% 4 years In 3 years 2 531 5,1% 5 years In 4 years 3 264 6,6% 21,2% 6 years In 5 years 3 930 8,0% 7 years In 6 years 10 445 21,2% 24,5% In 7 years 12 050 24,5% 8 years In 8 years 15 960 32,5% Cumulative 49 167 100% Source: Company data

12 Alternatives Evaluation Alternatives Evaluation FX rate of Final FX rate (sum conversion Time Period of Strike Spot price at of price of FX deal (minimum of Option Premium period hedging price expiration date and option spot and strike premium) prices) 1 year 1,065 0,887 0,887 0,0160 0,903 2 years 1,079 0,895 0,895 0,0162 0,911 3 years 1,098 0,985 0,985 0,0165 1,002 4 years 1,115 1,120 1,115 0,0167 1,132 1 week 5 years 1,133 1,227 1,133 0,0170 1,150 6 years 1,151 1,211 1,151 0,0173 1,168 7 years 1,168 1,260 1,168 0,0175 1,186 8 years 1,186 1,353 1,186 0,0178 1,204 The aggregate FX rate (at which all the FX gap was closed, if we start hedging on the 1 st week) = 0,903 * 0,7% + 0,911 * 1,3% + 1,002 * 5,1% + 1,132 * 6,6% + 1,150 * 8% + 1,168 * 21,2% + 1,186 * 24,5% + 1,204 * 32,5% = 1,165 Source: Bloomberg, Team Estimates

Solution 13 Solution Spot rates 1,8 1,6 1,4 1,2 Speed Single FX No Strategy Grid forward options hedging $/ € ratio 1 Exchange 0,8 spot 1.149 1.008 1.023 1.355 rate $/ € 0,6 Source: Bloomberg, Team Estimates 0,4 0,2 0 1 20 39 58 77 96 115 134 153 172 191 210 229 248 267 286 305 324 343 362 381 400 419 weeks Source: Bloomberg

Alternative approaches 14 Alternative approaches Continuous futures It allows to mitigate significant negative movements of FX rate and to be close to current FX rate. Although, this contract requires cautious approach to rolling position. “Double hedge” This approach includes two levels of hedging. The first level is a typical hedge contracts (forwards or options). The second level allows mitigating risk of volatility. “SPOT - swap combo” This approach gives the opportunity to operate in the market for all hedging time. The technique is to buy foreign currency by SPOT FX rate.

Counter-party default risk 15 Counter-party default risk Monitoring hedge counterparty risk arising from changes in the market value of EADS’ derivatives. To mitigate the credit default risk we need to carefully estimate creditworthiness of the banks we deal with.

Synthetic credit rating model 16 Synthetic credit rating model Data The aim of the analysis: Possibility to determine banks’ credit banks credit ratings ratings in every period of time; Possibility to determine banks’ credit ratings of those banks, which do not have in order to minimize option financial statements premium Sample sovereign credit ratings of the countries, in which banks operated 334 banks, which had long- term credit ratings of S&P, Moody’s or Fitch and whose Source: Bloomberg financial statements were disclosed

Synthetic credit rating model 17 Synthetic credit rating model Credit rating Score AAA 6 AA 5 A 4 BBB 3 BB 2 B 1 CCC / C 0 Where w(i) – weight of financial factor i (sum of all the weights is equal to 1) Factor score(i) – score of financial factor i (varies from 0 to 1)

Synthetic credit rating model 18 Synthetic credit rating model Tier 1 capital Cash / Demand Total assets, Factor ROA, % ratio, % deposits bln. $ score <12.51 <0.32 <0.07 <4.7 0 12.51 - 13.87 0.32 - 0.60 0.07 - 0.21 4.7 - 10.3 0.2 13.87 - 14.86 0.60 - 0.87 0.21 - 0.39 10.3 - 22.7 0.4 14.86 - 16.10 0.87 - 1.13 0.39 - 0.61 22.7 - 42.4 0.6 16.10 - 18.0 1.13 - 1.62 0.61 - 0.98 42.4 - 121.7 0.8 >18.0 >1.62 >0.98 >121.7 1 Factor Weight Tier 1 capital ratio 6,2% ROA 26,3% Cash / Demand deposits 25,7% Total assets, bln. $ 41,8%

Credit risk mitigation: default probabilities 19 Credit risk mitigation: default probabilities

Credit risk mitigation: limits 20 Credit risk mitigation: limits Criteria: PD > 2% -> Lim=0% PD < 0.5% -> Lim=100% Lim = 0.5% / PD

Credit risk mitigation: limits 21 Credit risk mitigation: limits Criteria: PD > 1% -> Lim=0% PD < 0.1% -> Lim=100% Lim = 0.1% / PD

Risk mitigating with downgrade trigger approach 22 Risk mitigating with downgrade trigger approach Stating Downgrade Trigger Covenant in the Forward Contract Bank’s credit EADS’s credit rating rating falls falls Bank has an option to EADS has an option to close out close out the contract at the contract at current market current market price price

Risk mitigating with collateralization approach 23 Risk mitigating with collateralization approach Specifying Forward Exchange Rate and Calculating Threshold Subjecting to mark-to-market Exchange Rate Exchange Rate moves in Bank’s moves in EADS’s favor favor EADS posts Bank posts EADS refuses to Bank refuses to collateral to collateral to post collateral post collateral equalize a equalize threshold threshold Bank has an option EADS has an option to close out the to close out the contract at current contract at current market price market price

24 Thanks for your attention