Difficulty of Measuring Exchange Exposure

Aaron Bigbee International Financial Management Harvard Business School Prof. Mihir Desai

The Difficulty of Measuring Currency Exposures: The Case of Boeing Introduction Should Boeing’s CFO worry about managing currency risk? A McKinsey Quarterly article from 1996 provides one answer: stay away from managing currencies, it advises, since the existence of multiple drivers of cash flow renders attempts to control currencies ineffectual.1 Two asset managers, writing in 2004 after studying 1,691 stocks from 24 countries, agree when they conclude that “most companies are currency insensitive, once one adjusts their returns for general market factors.”2 Boeing itself dedicates only a 7line paragraph in its 148-page 10-K to discussing foreign exchange risk, finishing by noting, “…these [foreign-exchange related] commitments do not create material market risk.”3 So why should Boeing in particular be concerned? The problem is that Boeing, like many other companies, may not be measuring all of its currency exposures. Quantifying and hedging currency exposure is unfortunately not as easy as merely buying futures for all FX-related contracts. In many cases, this can actually worsen the problem substantially. Consider the case of Lufthansa, one of Boeing’s customers4. The airline, in 1984, expecting the dollar to appreciate, acquired a $1.5B forward contract to cover 50% of a $3B contract with Boeing. Intuitively, this seems like a no-brainer: lock in today’s currency prices and sleep soundly. There was a catch, however. Lufthansa’s cash flow, because of the structure of the airline industry, was also effectively dollar-denominated. I.e., it had a natural hedge, which meant that if the dollar appreciated, its cash flow rose. Thus, when an unexpected dollar depreciation occurred—to the tune of 30%--Lufthansa was left with both lower cash flows and a large FX loss on a hedge that was actually unnecessary in the first place. Purchasing the forward had actually increased...