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Author: David Carter Publisher: ISBN: Category : Languages : en Pages : 33
Book Description
Set in June 2001, the case places the student in the role of Scott Topping, Director of Corporate Finance at Southwest Airlines. Scott is responsible for the airline's fuel hedging program. The case describes the importance of jet fuel hedging in the airline industry, the volatility of jet fuel prices, hedging strategies available to manage jet fuel price risk, and related issues. [Note: The time period of the case allows the instructor to discuss additional issues not specifically addressed in the case such as the impact of September 11th, 2001 terror attacks on the airline's hedging strategy and the collapse of Enron (e.g., counterparty credit risk in hedging).]Southwest Airlines has a business model based on being a low cost provider and has been very successful at offering the lowest airfares in the industry. This business strategy has effectively resulted in a consistently increasing market share over the years. A dominant factor on the expense side of its business is the cost of fuel. Fuel is the second largest expense behind labor. Most recently, fuel costs have reached the highest annual average over the six-year period from 1994 to 2000 at $0.7869 per gallon in 2000. This fact has led to the increased importance of minimizing fuel cost for 2001 and beyond. To mitigate the sensitivity to fuel prices, Southwest has consistently hedged its fuel usage but wants to reevaluate the strategies it employs. As listed in the case, the student is asked to evaluate the following hedging strategies: (1) doing nothing, (2) hedge using plain vanilla swaps, (3) hedge using options, (4) hedge using zero cost collars, and (5) hedge using futures contracts.The case is intended for use in an advanced corporate finance course or risk management at the graduate level. However, the case can also be used in an undergraduate risk management course.
Author: David Carter Publisher: ISBN: Category : Languages : en Pages : 33
Book Description
Set in June 2001, the case places the student in the role of Scott Topping, Director of Corporate Finance at Southwest Airlines. Scott is responsible for the airline's fuel hedging program. The case describes the importance of jet fuel hedging in the airline industry, the volatility of jet fuel prices, hedging strategies available to manage jet fuel price risk, and related issues. [Note: The time period of the case allows the instructor to discuss additional issues not specifically addressed in the case such as the impact of September 11th, 2001 terror attacks on the airline's hedging strategy and the collapse of Enron (e.g., counterparty credit risk in hedging).]Southwest Airlines has a business model based on being a low cost provider and has been very successful at offering the lowest airfares in the industry. This business strategy has effectively resulted in a consistently increasing market share over the years. A dominant factor on the expense side of its business is the cost of fuel. Fuel is the second largest expense behind labor. Most recently, fuel costs have reached the highest annual average over the six-year period from 1994 to 2000 at $0.7869 per gallon in 2000. This fact has led to the increased importance of minimizing fuel cost for 2001 and beyond. To mitigate the sensitivity to fuel prices, Southwest has consistently hedged its fuel usage but wants to reevaluate the strategies it employs. As listed in the case, the student is asked to evaluate the following hedging strategies: (1) doing nothing, (2) hedge using plain vanilla swaps, (3) hedge using options, (4) hedge using zero cost collars, and (5) hedge using futures contracts.The case is intended for use in an advanced corporate finance course or risk management at the graduate level. However, the case can also be used in an undergraduate risk management course.
Author: Gjest Andreas Breistein Publisher: ISBN: Category : Languages : en Pages : 73
Book Description
Negatively, with the level of activity in the commercial aviation industry will have severe effects on the value of jet fuel price hedging. The next part is a brief introduction to the practice of hedging commodity prices with different types of derivatives. This is a concise follow-through of the different aspects one has to consider when hedging commodity prices. Airlines who want to utilize financial commodity markets while minimizing the probability of losses need thorough knowledge about these markets. To end with, the characteristics of the crude oil and jet fuel prices and their implications for the airline industry are examined. This chapter is an extension of the previous one and is supposed to provide additional knowledge about the challenges of jet fuel price hedging. The two last sections give the reader an educated understanding of how some airlines have been able to utilize the commodity markets better than others.
Author: Mohamed Huzam Publisher: ISBN: Category : Languages : en Pages : 206
Book Description
The cost of jet fuel is the second largest operating expenditure in the airlines sector. Even a small increase in the fuel price often leads to a significant increase of expenditure on the operating cost of the airlines. Airlines use derivatives as hedging instruments for hedging their fuel requirements. However, derivative contracts on jet fuel, is not often traded in exchanges and the airlines engages themselves in cross hedging. This practice exposes them to another risk known as basis risk, while protecting them from the price risk. The primary objective of this paper is to look into the effectiveness of cross-hedging practiced by the airline industry. It looks into the problem of basis risk attempting to identify its' significance in terms of un hedged exposure it creates which could possibly lead to very significant financial losses. The effectiveness of hedging strategy of Malaysia Airlines was analyzed using secondary data obtained on the proxy commodity used by the airline. The data was analyzed using standard practices of airline industry in designing an optimal hedge. The calculations made attempts to identify the proportion of the price risk volatility that can be hedged and the proportion of the exposure that remains un hedged, when the said proxy is used to hedge jet fuel. The result showed that a significant portion of the price risk volatility remained un-hedged. This finding was in agreement with the established theory that high correlation between commodities does not remove the basis risk. It concludes that along with many other factors, the un-hedged exposure due to basis risk would have contributed to the losses suffered by the airline in their fuel hedge for the year 2011, unless precise measures are taken to hedge the basis risk.
Author: Simo M. Dafir Publisher: John Wiley & Sons ISBN: 111902675X Category : Business & Economics Languages : en Pages : 250
Book Description
A hands-on guide to navigating the new fuel markets Fuel Hedging and Risk Management: Strategies for Airlines, Shippers and Other Consumers provides a clear and practical understanding of commodity price dynamics, key fuel hedging techniques, and risk management strategies for the corporate fuel consumer. It covers the commodity markets and derivative instruments in a manner accessible to corporate treasurers, financial officers, risk managers, commodity traders, structurers, as well as quantitative professionals dealing in the energy markets. The book includes a wide variety of key topics related to commodities and derivatives markets, financial risk analysis of commodity consumers, hedge program design and implementation, vanilla derivatives and exotic hedging products. The book is unique in providing intuitive guidance on understanding the dynamics of forward curves and volatility term structure for commodities, fuel derivatives valuation and counterparty risk concepts such as CVA, DVA and FVA. Fully up-to-date and relevant, this book includes comprehensive case studies that illustrate the hedging process from conception to execution and monitoring of hedges in diverse situations. This practical guide will help the reader: Gain expert insight into all aspects of fuel hedging, price and volatility drivers and dynamics. Develop a framework for financial risk analysis and hedge programs. Navigate volatile energy markets by employing effective risk management techniques. Manage unwanted risks associated with commodity derivatives by understanding liquidity and credit risk calculations, exposure optimization techniques, credit charges such as CVA, DVA, FVA, etc.
Author: Britta Berghöfer Publisher: ISBN: Category : Languages : en Pages : 30
Book Description
The aviation industry is characterized by low profit margins and a constant struggle with skyrocketing fuel costs. Financial and operational hedging strategies serve aviation managers as a tool to counteract high and volatile fuel prices. While most research on fuel hedging has concentrated on the U.S. airline market, this paper is the first study to include airlines from Asia and Europe. We analyze 64 airlines over 10 years and find that Asian carriers are more negatively exposed than European airlines but less exposed than North American airlines. In contrast to Treanor, Simkins, Rogers and Carter (2012), this study finds less significant negative exposure coefficients among U.S. carriers. Using a fixed effects model we reject the hypothesis that financial hedging decreases risk exposure. One possibility is that the decreased volatility in jet fuel prices over the past few years has perhaps made airlines less exposed to fuel prices and hence, financial hedging less effective. However, operational hedging, defined by two proxies for fleet diversity, reduces exposure significantly. A one percent increase in fleet diversity, calculated with a dispersion index using different aircraft types, reduces the risk exposure coefficient by 2.99 percent. On the other hand, fleet diversity, calculated with different aircraft families, reduces exposure by 1.45 percent. Thus, aviation managers have to balance the fleet diversity between operational flexibility and entailed costs.
Author: Brian Hornung Publisher: ISBN: Category : Agency (Law) Languages : en Pages : 120
Book Description
Airlines commonly employ hedging as a risk management strategy to protect themselves against sudden, unpredictable increases in the price of jet fuel. In a seminal paper by Carter, Rogers, and Simkins (2006), it is established that jet fuel hedging by airlines increases the firm value of the airline. This dissertation replicates their study using an expanded dataset over a greater period of time. This study finds a smaller "hedging premium" than Carter, Rogers, and Simkins (2006). It is shown that the leasing of aircraft plays an important role in the relationship between the hedging premium and capital expenditures. The measure of jet fuel hedging used in the previous studies, the percentage of next year's fuel requirements hedged, accounts for the amount of hedging done by the airline, but it does not consider the performance of the jet fuel hedges. This dissertation for the first time determines the effect of jet fuel hedging performance, as measured by the realized gains and losses from jet fuel hedging, on the value of the firm. The analyses find that the realized gains and losses have a negative relationship with firm value. However, after identifying outliers (such as the significant hedging losses in 2009 resulting from falling jet fuel prices during the financial crisis) using a simple box plot and removing them from the sample, realized gains and losses show a positive correlation with firm value. Furthermore, successful hedging may induce principal-agent issues such as buying market share behavior. When an airline experiences a run of hedging success, a manager may mistakenly believe that the cost of jet fuel is decreasing. This is not the case, however, as the cost of using jet fuel is the price that can be received selling it on the open market, not the price paid for the jet fuel. A manager may attempt to pass on the "savings" to consumers in the form of lower fares, lowering the price below its profit-maximizing level. This in turn can increase the airline's market share, although it comes at the expense of reduced profit. This dissertation tests the relationship between successful jet fuel hedging and market share. A positive and statistically significant correlation between successful hedging and market share is found for Southwest Airlines and American Airlines, two carriers known for successful hedging, but statistically insignificant results for smaller carriers Alaska Airlines and JetBlue Airways.
Author: David Carter Publisher: ISBN: Category : Languages : en Pages : 49
Book Description
This paper investigates the fuel hedging behavior of firms in the US airline industry during 1994-2000 to examine whether such hedging is a source of value for these companies. The investment climate in the airline industry conforms well to the theoretic framework of Froot, Scharfstein, and Stein (1993). Specifically, airline industry investment opportunities correlate positively with jet fuel costs, while higher fuel costs are consistent with lower cash flow. Given that jet fuel costs are hedgeable, airlines with a desire for expansion may find value in hedging future purchases of jet fuel. The results show that jet fuel hedging is positively related to airline firm value. The coefficients on hedging indicator variables in regression analysis suggest that the hedging premium constitutes approximately a 12-16% increase in firm value. We find that the positive relation between hedging and value increases in capital investment. This result is consistent with the assertion that the principal benefit of jet fuel hedging by airlines comes from reduction of underinvestment costs.
Author: David Carter
Author: David Carter
Author: Gjest Andreas Breistein
Author: Mohamed Huzam
Author: Simo M. Dafir
Author: Mlibazisi Ngwenya
Author: Britta Berghöfer
Author: Rachel A. Emrath
Author: Brian Hornung
Author: David Carter
Author: