The board should retain Heinz Ruhnau as Chairman.
Ruhnau evaluated the decision based on the information and data he had at that time. The US dollar had been rising for the past 3 years and was at an all time high. He used the existing facts and his strong instinct that the dollar would depreciate to make the partial forward cover choice. He was wise and knowledgeable enough to not rely only on his instincts when hedging as the money belonged to the company and stakeholders. Rather than fully going with his instincts and understanding that the market in not predictable he chose the safer option of a partial forward cover rather and 100% uncovered. …show more content…
Show the calculations in appendix
The five possible strategies to mitigate the foreign exchange risk that Lufthansa was facing were uncovered, full forward cover, partial forward cover, currency option and money market hedge.
The money market hedge though eliminates all currency exposures, it required a high capital investment immediately. Also, Lufthansa had practices and covenants in place that restricted the types, amounts and currencies of denominations in which it could carry on its balance sheet. So, this option was eliminated from consideration. The hedging strategy Ruhnau choose was partial forward cover. At that point of time the dollar had been appreciating consistently for three years against the Deutche Mark (DM). The hedging strategy seemed to be appropriate. The calculations shown in appendix 1 clearly shows that if dollar kept on appreciating (assuming from 3.2 DM per dollar to DM 3.4 per dollar) the partial cover would have cost DM 50 million less than covered and DM 46 million less that the foreign currency option hedge would cost. But the dollar weakened, it plummeted to a spot rate of DM 2.3 per dollar by January 1986. Although Ruhnau had a gut feeling that the dollar will weaken in the coming year, but it wasn’t his money to gamble and couldn’t act on his personal feelings. …show more content…
Is it fair to judge transaction exposure management effectiveness with 20 /20 hind sight?
It is unfair to judge transaction exposure management effectiveness with 20 /20 hind sight. Since no one can predict what the future holds and while taking a decision can only.
Managerial behavior and the outcome must be interpreted based on both decision making at a specific point in time with perception of risks and uncertainties of decisions made about the future and the subsequent results of those decisions. A necessary part of risk management is to make management decisions that protects the firm, it shareholders and creditors against adverse impact of exchange rate movements. The loss of DM 225 million was calculated from the value of DM on January 1986 which is unfair because no body knew what the exchange rate would be a year from when the decision was made. The dollar plummeted sharply beyond anyone’s expectation. An effective and fair measure of performance would be measuring outcomes as hedged against corporate bench marks which are agreed upon prior to