Airline Foreign Exchange Risks Finance Essay - Free Essay Example

Sample details Pages: 7 Words: 1980 Downloads: 9 Date added: 2017/06/26 Category Finance Essay Type Research paper Did you like this example? Airline carriers sell tickets in many part of the world, and each country has different policies that govern their currencies. Countries such as the Great Britain uses Pounds sterling (BGP), Japan with Yen, and United of America with Dollar and some parts in EU uses Euros. Basically airlines around the globe fly to different parts of the world, and majority of these airlines have offices around the globe which incur operating expenses in the currencies of the countries they operate. Don’t waste time! Our writers will create an original "Airline Foreign Exchange Risks Finance Essay" essay for you Create order Exchange rate has become a big threat to the airline industry. The turbulence of an exchange rate makes it impossible for airlines to match in transaction and timing of foreign currency expenses. The airlines around the globe have a huge task of managing revenues,assets, capital investments and liablities in the local and foreign currencies. More often than not airlines minimise the risk of exposure to large currencies. Allthough fluctuation of foreign exchange happens because of supply and demand for currencies in the airline industry, airlines must ensure that foreign exchange exposure is limited, or they face financial contrain at the end of the financial year. There are different possibilities in dealing with foreign currency exposure. Either the airlines do nothing but depend on the spot market, or hedge the risk by having a negative by buying a forward. Spot market can be difine as a market in which currencies are sold for cash and immediately transfered to the airline s. Spot can help the airlines operate whenever an infrastructure exists for conducting transactions. Aim and Objectives The aim of the project is to explore the relevance of airline foreign exchange risk and identify other present factors, such as currency and hedging which could affect the airline industry. The objectives below would attain the aim of the project. They are: To evaluate the foreign exchange risk in the airline industry To define how the currency issue is changing the airlines Review the result against the finding of other research Evaluate how hedging on fuel has greater profit than airline purchasing fuel at current market prices. Literature Review The following literature review will examine the research project topic. The literature will be examined and reviewed critically. Literature review is an analysis of previous works relating to the subject being examined. Hart considers a review to be important as it would provide an understanding of your topic, of what has already been done on it, how it has been researched, and what the key issues are. (Bell 2005). According to a case study by Daniels, Radebaugh, and Sullivan, 3M uses operational methods for managing the foreign-exchange risk to which its overseas operations are exposed.   In its annual report, 3M states its policy towards foreign-currency translation:   local currencies generally are considered the functional currencies outside [domestic operations], and therefore 3M implements a current-rate method of translation in its accounting practices (Daniels, et al, 728).  [1] The subsequent literature review will examine the literature which is for and against the significance of foreign exchange risk policy in decisive currency value in different countries. This review would identify the methods used and characteristics of various airline industries which have been examined with the aim to identify any variation to the theory surrounding foreign exchange risk in the airline industry. The theories will be discussed in the theoretical literature. THEORETICAL LITERATURE There has been research on the effects foreign exchange risk has on the airlines. However these researches were generated from three theoretical literatures which provided explanation of the effects. Hedging reduces the expected cost of financial distress. According to Mayers and Smith (1982), and Smith and Stulz (1985)), Hedging may also be motivated by tax incentives. They explain that when firms face a convex tax function, hedging should help reduce the expected taxes. However, Leland (1998)  [2]  explained that Hedging can also increase the debt capacity, therefore realising greater tax advantages from greater leverage. Many researchers are keen to know whether the value of hedging increases in the airline industry. According to the Financial Management (Financial Management Association, spring 2006 ), David A. Cater, Daniel A. Rogers, and Betty J. Simkins stated in their research that currency had a significant effect on the foreign exchange market. The relationship between foreign currency, hedging and Tobins Q was examined by Allayannis and Weston (2001) and they concluded that hedging is associated with higher firm value. On the other hand, according to Jin and Jorion (2004), there is no relation between hedging and firm value for oil and gas procedures. Pulvino (1998, 1999) also found that distressed airlines are forced to sell aircraft at below-market prices. It is also noted that (Froot et al. 1993), that firms facing significant expected distress costs will choose to under invest. Based on the theories it is evident that as the currency in different countries changes, it increases the expenses of the airlines and it would also increase as long as there is no equivalent decrease in the growth rate. For example, Laker Airways, one of the British airline in the 1980s, the airline borrowed huge amount of dollars to purchase new aircrafts, the airline eventually purchased in fixed payment dollars, unfortunately for the airline they rece ived more than half of the airlines revenue in Pound sterling. This led the airline to bankruptcy. This illustrates how serious currency risk can easily affects the airline industry unaware. However, a rise in the payout ratio of an airline would decrease the amount of money available to be reinvested in the company to yield more profits. Therefore, the growth rate would fall. It can be concluded that an increase in dividend could have two opposing effects if the earnings of the airline has not increased inline. The expected present and future foreign exchange risk in the aviation industry also provides a signalling effect and could affect the value of the airline capital. For example, the way an airline collects its revenue is different to most other business transactions. According to International Civil Aviation Organization (ICAO) An airline is constantly exposed to transactions in different currencies that are different from the airlines home currency. Airlines usually capture currency of collection while processing tickets in its revenue accounting system and they will be used to determine foreign currency component and multi-currency mix of sales for every route group operated by the airlines  [3] According to the case study of Froot, Scharfstein, and Stein (1993) explained we are the first to find empirical evidence pointing to the source of value from hedging operations. We find that the airline industry exhibits two characteristics consistent with the general assumptions the airline industrys history of investment spending is not negatively correlated with jet fuel costs, as one might expect. In fact, the relation between these two variables is largely positive. Second, airlines face significant distress costs  [4]  . A typical example is the finding of Pulvino (1998, 1999) which shows that distressed airlines are forced to sell aircraft at below-market prices. Additionally, firms facing significant expected distress costs will choo se to under invest. (Froot et al. 1993) METHODOLOGY Methodology refers to the philosophical basis on which the research is founded and the technique used to collect the data is the method. (White 2005) The methodology adopted in this thesis is the analysis of secondary data with the aim of establishing whether any of the theories relating to the effect of currency will be present in airline foreign exchange risk. Secondary data as described by Saunders. M (2007) is used to illustrate descriptive and explanatory research and may contain raw data which has little or no processing or complied data that have received some form of selection or summarising The secondary data for this thesis will be drawn from different airlines around the world and how they manage risk will be examined. A hypothesis question will be drawn from the information. The information will be analysed using different airline strategies to help identify a correlation between the two variables. An example of the hypothesis question is illustrated below: H1: Foreign exchange risk has a significant effect on the airline industry VS H2: Foreign exchange risk does not have a significant effect on the airline industry. As there are limitations to the data available a cross section of hypothesis will be carried out. Example, airline foreign exchange against or actual currency market share prices. The analysis of the information will aid in achieving the objectives of the thesis. RESEARCH QUESTION The project is important as it aims to identify the relevance of airline hedging strategies in an up-and-coming market where mainstream of the airlines choose to hedge fuel for a set amount of time with no instants outflow of cash. The proposed study would be concerning with the following questions: How does a multi currency affect the airline industry? Does aircraft cost affect airlines foreign exchange? How can airlines win through the turbulence of foreign exchange? DESCRIPTION OF DATA ANALYSIS Interviews will be transcribed by listening to the audiotape while reviewing the transcript word by word. During this process, all personal identifiers will be removed and a subject/interview code will be assigned to protect confidentiality. The researcher will code the content to look for common responses, ideas and feelings expressed in the interviews. A second and third person will also analyse the tapes and their transcripts in order to check for any coding carried out and subjective biases in analyses. In the data analysis below, pseudonyms will be used to protect respondents identities (Bowling, 1997). After collecting, collating, analysing and interpreting the data, the findings of the study will be presented. The findings of this study will be presented in a narrative manner by analysing the data under each question ETHICAL ISSUES Even though as a member of staff of an aviation company where the study was to be conducted, I have to be mindful of ethical considerations. One of my concerns is that of informant consent. As Grieg and Taylor 1999) suggested that in words they would understand, ensure that the subjects/ sample know what they are doing and enlighten the sample on the research and my role as a researcher and there in the matter. I will be sure to highlight that they are free to withdraw at anytime without any detriment. Furthermore, it will be made known to the sample what will be done with the data and who hear it. Another ethical concern is that of access to setting. According to Cohen and Manion (1994), permission must be seek from first the anonymous responsible for the sample and, then the sample. Therefore, I will seek permission from the head of the department for permission to use the company lounge and the members. I will provide to provide an informed letter from the university and also personally acquaint the year tutor with the proposed topic and procedure. In most research, samples are preferred to be anonymous. Therefore consent for confidentially and privacy would be maintained. Real names will not appear in report /write up and other identifying information will not appear. Cooperation shall be a priority and do not take advantage of the power relations between employers and the staffs. IDENTIFICATION OF POTENTIAL PROBLEMS AND LIMITATIONS OF THE STUDY Time constraints of the semester and job call for less time than maybe sufficient for an aviation study. By being in an aviation company for only seven months, there are hurdles. The companys culture and leadership practice pose limitation for vital information that could help the study. The terms and condition of the company led to screening of some information gathered during the interview. The reason for this action was to protect the companys brand and position in the aviation industry. REFRENCE https://207.36.165.114/NewOrleans/Papers/4401786.pdf lhttps://findarticles.com/p/articles/mi_m4130/is_1_35/ai_n26898315/ https://www.afajof.org/pdfs/2004program/UPDF/P330_Corporation_Finance.pdf Goldberg, Laura. Hedging Your Jets. Houston Chronicle 5 Jan. 2001. Factiva. 10 Nov. 2004 https://www.afajof.org/pdfs/2004program/UPDF/P330_Corporation_Finance.pdf https://www.accessmylibrary.com/article-1G1-147058051/does-hedging-affect-firm.html