British Airways: Foreign Exchange Exposure

Company Overview

British Airways is the largest airline in United Kingdom dealing with both international destinations and flights. It is the second largest airline behind easyjet measured by passengers carried. It was founded in 1972 and privatized in 1987. The company has been involved in various alliances with companies like Oneworld Airline, American Airlines Qantas and Canadian Airlines. In 2011 it merged with Iberia creating International Airlines Group (IAG) and listing it on the stock exchange. Since then it has purchased British Midland International (BMI). The company has maintained a stream of subsidiaries in various countries including BA CityFlyer, OpenSkies and hence developed its fleet size to 262 with 169 destinations excluding code-shares and subsidiaries. Its hubs are in London Heathrow Airport and Gatwick Airport. The company has also maintained several codeshare agreements and partnership with other companies like WestJet, Loganair, Finnair and several others. The company has employees represented by a number of trade unions with each employee segment having a different trade union representing it. The company as per 2011 fiscal year indicated an increasing revenue registering 10.827 billion pounds (Punzel, 2008).

Exposure

Exposure of foreign exchange is that sensitivity regarding a real value of domestic currency of the assets, operating incomes and liabilities to changes unanticipated that may occur in rates of exchange. The risk of foreign exchange can be determined by of value of variance of domestic currency of all liabilities, assets and operating income which is attributed rates of exchange that are unanticipated (Wang, 2009). British Airways is a multinational corporation operating in various countries through the alliances, mergers, codeshares, partnerships and subsidiaries which are affected by unanticipated variation in the market. This partnership, acquisitions and joint ventures represents investments of the company which are affected by foreign exchange exposures due to the existence of various rate of exchanges and different interest rates. A firm’s value sensitivity to unexpected movements in the rate of exchange provides the rate of exchange risk of a firm. International transactions can be considered as the primary source of foreign exchange exposure. Therefore variations in rate of exchanges may cause an increase or decrease in local currency terms for a firm conducting transactional operations (Cool & Goddard, 2006). This is the transactional exposure. British Airways is also faced with economic exposure which is as a result of variation in value of the projects stemming from the unexpected variation in the rate of exchanges. Translational exposure also affects British Airways where rate of exchange movements affects reporting of its finances. Most adverse has been the contingent exposure where it has faced both transactional and economic exposure on undertaking various negotiations and contracts.

The foreign exchange and interest rates exposure of the company can be ranked as follow: transaction exposure being high in the risk, the accounting exposure, and economic exposures. The volatility in the value of the dollar across trading countries has been a major issue affecting trade and posing greater risks to the company. Therefore it is vital that a company determines the best way to mitigate the various risks so as to operate effectively. Managing of these risks may a time be very costly, too complex or time consuming for a company (Siddaiah, 2010). This makes them assume that rate of exchanges will movement will be in a favorable direction or will remain at their present levels. However it is essential that these exposures be managed so as to minimize the effects of rate of exchange movements on profit margins and also facilitate pricing of products sold on international markets. It will also help in eliminating the need to accurately forecast the future direction of the rate of exchanges. British Airways requires protecting its competitiveness in the market with the various joint ventures and agreements entered into. This therefore would need to be protected in that if the value of the home country rises the company will be able to buy time to improve its productivity. Risks need to be reduced at a cost that is reasonable since most of the risk operating at an international market cannot be avoided (Horcher, 2011).

Companies operating in foreign markets or those affected by foreign rate of exchanges require that the management find a best way to manage the exposure for the success of the company. British Airways ensures that it undertakes risk management process to maintain the firm’s value and competitive advantage in the industry. Most contracts are dominated in the foreign currency hence any adjustment or variation in the foreign rate of exchange affects the firm’s value. Managing the risks successfully can ensure that a company reduces foreign exchange exposure. British Airways ensures that it identifies and measures the foreign exchange exposures as the first step in managing foreign risk process. Transaction risk is the one that highly affects BA. Measuring the risk helps in determining the exposure to be hedged. It is vital that both confirmed cash flows of foreign currency and the forecasted cash flows of foreign currency over a designated time period be determined to help in calculation of the net exposure. The variations in rate of exchanges directly affect the profit margins. Considering all this factors will ensure that the company’s exposure level is determined and fully analyzed. Developing of the company’s foreign exchange policy for BA was done by an understanding of when the foreign exchange exposure was to be hedged and instruments that are needed in every circumstance. Pre-transaction exposures cannot be ignored since BA trading prices are not easily changed in the global market place hence are fixed temporarily for a given period of time. The effects of these fluctuations are exerted on BA’s profit margins, cash flows and market value. Measuring of transactional exposure will assist in managing it and maximizing profitability, net cash flow and market value (KEVIN, 2009). This therefore requires that the management make implementable policies and strategies which will ensure that the risk is reduced of mitigated to maintain the expected profits and cash flows. BA has entered into several contracts and agreements which require to be fully settled. They are highly tied to financial activities and most important it involves high capitalization in the investments. Changes in cash flow due to lack of the company addressing the foreign exchange risks will be a great problem for the company where profits are cut of, cash flow are entered reduced and the firm’s value drops. When the firm’s value drops in a market where competition is high then BA will lose a considerable amount both in capital and value.

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