Case Study:A Strong Real Hurts Embraer

In August of 2003, Empresa Brasileira de Aeronutica SA (Embraer) of Brazil, the world's fourth-largest aircraft maker at the time (today it is the third-largest behind Boeing and Airbus and ahead of Bombardier), reported that net income had fallen by 87% for the second quarter, despite recent multibillion-dollar orders from JetBlue and US Airways, because of Brazil's stronger currency and foreign-exchange hedging losses. Embraer President Maurcio Botelho said that the company was "strongly hit by two factors beyond our control." He pointed out that the Brazilian real had appreciated by about 18% against the dollar during the quarter and that this had adversely affected Embraer. Embraer said that the appreciation raised its cost of goods sold, as well as its operating costs such as those for research and development and selling, general, and administrative expenses. At the same time, nearly all of Embraer's revenue came from exports. Its primary competitor in the regional jet market, Embraer's specialty, is Canada's Bombardier; to a lesser extent, Boeing and Airbus are also competitors. However, the biggest impact of the rising real came from $85 million in losses on currency swaps that Embraer used to convert its dollar-denominated liabilities into reais as a hedge. Embraer also lost money when Brazil's main export-credit agency, BNDES, delayed paying for $397 million in outstanding receivables. By the time BNDES made the payment, the real's strength meant that Embraer received fewer reais. In addition, BNDES had still not paid for $211 million of receivables for jets already delivered. Payments in reais are made at the spot rate in effect at the time of the payment.

1. (Excel) Suppose that Embraer's $608 million in dollar receivables mentioned earlier were outstanding at the beginning of the second quarter and that payment for $397 million was not received until the end of the quarter. The remaining $211 million was still outstanding at the end of the quarter. With an 18% real appreciation during the quarter, how much of a dollar loss would Embraer take on these receivables? In performing this calculation, consider that Embraer must first translate its dollar receivables into reais and then convert any loss measured in reais back into dollars.