Exchange rate behaviour and risks

FlyK - Background Information

FlyK is one of the leading airlines operating in Ghana. FlyK services all the domestic routes in Ghana, in addition to some major international airports in the ECOWAS sub- region, mainly Lagos, Abidjan and Monrovia. Over the years, FlyK has achieved significant growth, but competition from other airlines within the ECOWAS region has recently become fiercer, especially on the international routes. Other domestic operators, such as AfricaWorld, Passion Air and StarBow, have also been established, and are gaining a share of FlyKs domestic operations. Aviation experts believe that the industry is still a growth area, particularly within the ECOWAS sub-region and across Africa.

Currently, domestic operations in Ghana account for about 60% of FlyKs total revenues. Ticket prices are denominated in the currency of the country where the tickets are sold; hence FlyK receives revenues in Ghana Cedis, Naira and CFA Francs. Extracts from FlyKs financial statements over the past three years show that the currency composition of FlyKs revenues is approximately, 50% in Ghana Cedis,

20% in Naira and 30% in CFA Francs.

FlyK wet leases all its operating aircraft from an airline leasing company based in

Ireland. The annual lease charge is 1,000,000, and is paid in euros.

The functional currency of FlyK is the Ghana cedi and all foreign currency transactions and balances are translated into Ghana cedis using the exchange rate prevailing at the time of the transaction, or the hedged exchange rate if applicable.

Ghana Cedi

Ghana operates a floating exchange rate arrangement and, in the past two years, the Ghana cedi has suffered some depreciation against most international currencies. The continuous depreciation of the cedi is a major concern for many businesses operating in Ghana, including FlyK. The central bank, Bank of Ghana, took some measures recently to halt the depreciation of the cedi and its Governor, and the Governments

Minister of Finance has assured the markets of the Central Banks determination to

sustain the recovery of the cedi.

Board Meeting at FlyK

At a recent meeting of the Board of Directors of FlyK, Mrs Hayford, the Technical Director of FlyK, raised issues relating to the impact of the volatility of the cedi on the companys operations and further argued that the current system of pricing tickets exposes FlyK to even greater exchange rate risks. She suggested that FlyK should consider pricing its tickets in either US dollars or euros to minimise their exchange rate risks. The Chairman of the Board, Mr Suleman, deferred discussions on the matter to a Special Board meeting to enable the board discuss the issues raised in much detail. The special board meeting has been scheduled and Mr Suleman has asked the Director of Finance, Nana Gyasi, to make a presentation to the Board analysing all the issues raised by Mrs Hayford and suggesting possible actions that FlyK can take to minise its exposure to exchange rate fluctuations.

In addition, the Board is considering raising finance from international capital markets and will be interested in understanding on the company.

Memo from Director of Finance to Finance Manager

You are the Finance Manager at FlyK and report directly to the Director of Finance, Nana Gyasi.

From: Nana Gyasi, Director of Finance

To: Finance Manager

Subject: Impact of exchange rate volatility on FlyK

At the last Board of Directors meeting, issues relating to the impact of exchange rate volatility on the operations of FlyK were raised. Among other things, a board member suggested that we price our tickets in either US dollars or euros, instead of the current pricing arrangement.

From the financial press, you are also aware of some of the actions taken in recent times by the Bank of Ghana to stem the depreciation of the cedi.

I have been asked by the Board Chairman to give a presentation on the issues above at the next Board meeting. To help me prepare for the meeting, I would like you to send me a report addressing the following issues:

1. Explain what is meant by a companys exposure to foreign exchange risk and differentiate between the three types of exchange rate risks, and which of these risks is FlyK exposed to?

2. Evaluate the exchange rate volatility of the cedi relative to the currencies given above and discuss their impact on FlyKs costs, revenues and profitability.

3. Evaluate the implications of the suggestion to price our tickets in US dollars or euros and recommend the most appropriate currency to use if possible

4. I am tempted to suggest that we take a forward OR an OTC option contract on euros with one of the local banks (Barclays, SG and GCB Bank are being considered) to cover the annual leasing charges. I would like to have your thoughts on:

a. whether we should go for a full hedge, or a partial hedge might be possible; and whether a full hedge will always be better than a partial hedge (please provide an appropriate justification for your recommendation).

b. evaluate the benefits and risks of using either the forward contract and the option and make a recommendation to the board on the most suitable hedge strategy

5. Finally, the board is considering raising capital from international markets to finance our expansion strategy. What are the basic considerations the board should take into account when making this decision.

Group Exercise:

Working in your groups, prepare the Financial Managers report required by the

Director of Finance in the above memo.

Key Information:

1. This is a group report and each group is expected to submit only one report. A minority report can be accepted but please discuss with me first. The minority report should be attached to the main group report. The group report should indicate the names and ID numbers of all members.

2. Weighting: This coursework constitutes 50% of the overall module mark.

3. Word Limit: Your group report should not exceed 3,000 words (excluding

Tables and Figures)

Exchange rate behaviour and risks

Basis of Assessment	Weighting	Mark
Discussion on Exchange Rate Exposures (Memo point 1)	20
Evaluation of volatility of the cedi and its impact on FlyKs costs, revenues and profitability (memo point 2)	20
Evaluation of changing pricing strategy (memo point 3)	15
Evaluation of the forward versus options hedge (memo point 4)	20
Discussion on raising capital from international markets (memo point 5)	15
Quality of Presentation	10
Total	100