Background Information
United Airlines is one of the leading airlines in the United States. The corporation was founded in 1926, and it is headquartered in Chicago, Illinois. The estimated revenues of the business are more than the US $38.000 billion annually (“United: Corporate Fact Sheet” par. 3). In spite of significant revenues, the airline can be discussed as operating within unstable economic and social conditions and currency risk environments because United Airlines buys fuel and the necessary aircraft using Euro and US dollar. Ticket sales are associated with the use of different types of foreign currency. Additional currencies that influence operations and financial risks are the pound sterling, Japanese yen, and Swiss franc. In order to avoid risks connected with unexpected shifts in exchange rates, it is necessary to examine and analyze possible currency hedging strategies that can be used by United Airlines to eliminate risks and to propose the most effective strategy with the focus on the business’s basic approach to managing financial issues.
Currency Hedging Strategies
Currency hedging policies are approaches that are followed by companies in situations when it is necessary to minimize risks associated with unpredicted changes in exchange rates and the inability to predict future prices (Hull 121). Businesses can apply a variety of hedging policies to prevent adverse effects of changes in prices and rates, and these strategies include (1) natural hedging; (2) forward contracts; and (3) a collar strategy.
Natural Hedging
Natural hedging is the most typical procedure for the airline industry when airlines try to reduce financial risks while balancing costs and inputs in the same currency or while planning and setting all used currencies according to the determined exchange rate with references to the US dollar. In this case, the airline pays much attention to the constant analysis of expenses and incomings in order to balance the used currencies and match the costs and inputs with the focus only on one currency (Vasigh, Fleming and Humphreys 461). The benefit of this approach is the possibility to control the financial balance while matching incomings and payments. However, the disadvantage of this strategy is the inability to balance all currencies appropriately and avoid losses when the airline operates internationally and works with more than 20 currencies.
Forward Contracts
In order to minimize risks associated with changes in exchange rates, a company chooses to set agreements according to which it can pay only the fixed amount of money while following the set currency rate related to the date of signing the agreement. In this case, the main focus is on the home currency value that is regarded when the airline pays its partners and suppliers according to contracts (Vasigh, Fleming and Humphreys 462). In spite of obvious advantages for regulating the relations with suppliers and other stakeholders, this policy is not effective to address the issue of international sales of tickets and significant incomings in foreign currencies.
A Collar Strategy
This options strategy is characterized by tools that are used by firms to lock in the exchange rate of different currencies. If an airline plans to exchange currencies in a certain period of time, it can choose to buy and trade money at different exchange rates. The narrow range characteristic for these rates will be used as protection for a firm if unexpected changes in prices and currency rates will be observed. The problem with using this hedging strategy is associated with the choice of the currency on which it is necessary to orient (Vasigh, Fleming and Humphreys 462). Unexpected changes in the exchange rates can be non-beneficial for the company if the determined range cannot cover the difference.
Recommended Strategy for Currency Hedging in United Airlines
As it can be viewed with references to the review of currency hedge policies, no discussed strategies can guarantee absolute protection from financial risks and possible losses. Therefore, while designing a strategy that is appropriate for United Airlines, it is important to take into account all the mentioned advantages and disadvantages. In this context, natural hedging can be discussed as the least risky strategy in comparison with other options, and it is effective to balance incomes and expenses in the company when different currencies are actively used. Thus, it is important to analyze what currency dominates the financial structure in the company and to constantly monitor changes in exchange rates in order to march or balance incomings and expenses.
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However, the percentage of Euro in the financial turnover is also significant, and United Airlines should also use forward contracts for an 18-month period of time in order to minimize risks associated with changes in the exchange rates globally (“United: Corporate Fact Sheet” par. 10). It is expected to achieve the following proportion in the currency turnover: 50% for US dollars, 30% for Euro, and 20% for other currencies in order to be able to improve approaches to addressing changes in the financial and industrial markets.
The effective risk management strategy for United Airlines is based on combining two currency hedging strategies in order to reduce possible challenges and adverse effects of changes in exchange rates.
Works Cited
Hull, John. Options, Futures, and Other Derivatives. New York: Prentice Hall, 2012. Print.
United: Corporate Fact Sheet 2015. Web.
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Vasigh, Bijan, Kenneth Fleming, and Barry Humphreys. Foundations of Airline Finance: Methodology and Practice. New York: Routledge, 2014. Print.