Homework - Case Study

Porsche Exposed
1. Exchange Rate
Exchange rate refers to the value of one nation’s currency that can be exchanged for the currency
in another nation. Euro’s exchange rate tells us, for instance, how much a euro is worth in some
foreign currency. Usually, exchange rates are being determined by the foreign exchange market,
also known as forex. Exchange rates can be classified as fixed or floating. Central banks
determine fixed exchange rates, while the mechanism of market demand and supply determines
floating exchange rates. However, exchange rates can highly affect businesses, especially if they
are operating abroad. Usually, when products are bought from a foreign country, their costs may
change if the exchange rate changes. The same happens when products are sold to a foreign
country. Exporting and importing firms are also affected by the changes in exchange rates. If
there is a depreciation of a domestic currency, the exports will be cheaper and exporting firms
can benefit from such situation, while importing firms may face higher costs of imports. In
contrast, an appreciation of the domestic currency does the opposite. In both cases, there is a
group who wins and a group who loses. Changes in exchange rates can also affect production,
especially for those firms who are producing domestically, but selling abroad. Therefore, these
firms are exposed to risk while making some important choices, in deciding whether to increase
their profit margin or reduce the foreign price. If the domestic currency depreciates, those firms
who import materials in order to make their products, will have to pay more for them. This can
also generate a negative consequence for all consumers who purchase imports and those on fixed
wages. A change in exchange rate can lead to some catastrophic losses for large companies,
meaning that they are constantly exposed to a huge risk. However, the impact of the exchange
rate depends on some factors, including the elasticity of demand, percentage of imported raw
materials, economic growth in foreign countries, inflation, fixed contracts, and existence of
appreciation or depreciation. As already stated, differences in exchange rates can also have a
beneficial impact, since they provide a greater certainty for importers and exporters. This
encourages international trade and investment and contributes the government while helping it to
maintain low levels of inflation.
2. Currency Hedging
Currency hedging represents a method, used by firms, which involves entering a contract to
provide a protection from unexpected, expected or anticipated changes in currency exchange
rates. It includes the usage of financial instruments, referred to as derivative contracts. For
instance, when a firm has the obligation to deliver 2 million dollars in eight months, it can use
currency hedging to avoid the risk incurred by the change in exchange rate. Thus, the firm can
successfully hedge this risk by entering a contract to buy 2 million dollars on the same day. By
doing this, the firm can purchase and sell in the same currency on the same day. Currency
hedging is achieved by the purchase of options and futures contracts, in order to avoid financial
risk. Some other ways of engaging in currency hedging involve the usage of loan denominated in
a foreign currency, currency options, and cylinder options. Using currency hedging helps firms
to transfer the foreign exchange risk to a business that will carry the risk. However, in order to
set up a hedge, firms are exposed to some costs. If the change in exchange rate fails to be
favorable to the hedge, company can forgo any profit. Anyone who invests abroad is exposed to
the currency risk. Therefore, currency hedging method was designed to limit the impact of the
exchange rate fluctuations and help all investors and businesses who own international holdings.
3. Speculating on Currency Movements
When investors feel that the exchange rate is not rightly valued and that it may easily change
sometime in the future, they can decide to sell or buy the currency in order to make a profit. This
is referred to as currency speculation. Thus, if the investor feels, for instance, that the currency is
overvalued, he or she should sell owned reserves. Besides selling, currency speculation also
includes buying and holding currencies, depending on the investor’s expectations and beliefs.
Changes in exchange rates are usually a consequence of changes in different economic factors.
These include economy growth, inflation, industrial production, revolutions, leadership changes,
and many others. Therefore, investors must be aware of these economic factors in order to make
right decisions regarding the purchase and selling of currency pairs. However, currency
speculation often increases the amount of risk that an investor is exposed to. Prediction of the
future events, involving their influence on exchange rates, is very difficult. For example, if an
investor believes that that the dollar will appreciate against the Euro and buys US dollars using
Euros, but the US dollar does not appreciate, the investor can lose money. Although currency
speculation can increase liquidity, it can also have many significant consequences on a nation’s
economy, especially on importers and exporters that can encounter with abrupt changes in the
prices when relevant currency values fluctuate.
4. Porsche Exposed
Porsche, the famous manufacturer of performance sports cars, considered a revaluation of
its exchange rate strategy, due to criticism and requests from the stock exchange and analysts’
growing concern. During the time, the company focused on its currency hedging strategy which
has not been causing any negative consequences for its business. However, many experts
believed that the company was just lucky and that it would not be able to adjust to the future
currency movements. Furthermore, Porsche was often criticized for its independent thought,
occasional stubbornness, and refusal of quarterly reporting. Thus, the company soon decided to
implement a new aggressive strategy in order to cover its currency exposure.
Porsche manufactured its three popular model lines in Germany and Finland, making its
cost base mainly in Euro. However, it possessed the largest mismatch when it comes to the
difference between its production and selling locations, among the largest European-based
automobile manufacturers who were exposed to changes in exchange rates. 42% of its global
sales were concluded in North American markets, while 11% was additionally concluded in the
United Kingdom. While the other European automakers were focusing on the increase of natural
hedging by shifting production to those countries that they were selling their products to, Porsche
believed that its performance in manufacturing and engineering is enough to cover such costs
and increased its put option hedging. Therefore, the company became the most exposed to
changes in exchange rates, when it comes to the European automobile makers. In 2000, Porsche
started purchasing put options on the US dollar. The company believed that such strategy would
allow it to exchange US dollars, that come from North American car sales, into euros at specific
exchange rates, at some future dates. Throughout the years, company continued increasing its put
option hedge purchases in order to become fully hedged for its sales, according to the 2006
model year. In order to execute this strategy, the company decided to create a three-year rolling
portfolio of put options with prices that are based on their currency speculations and forecasts.
However, the strategy made Porsche exposed to a huge financial risk, as also noted by many
analysts. It relayed on the company’s beliefs and predictions, which always represented a risk for
such businesses. Porsche still expected the dollar to continue failing in its value and euro to rise.
Thus, it decided to purchase put options that would provide the important profitability and
protection for the company, since it was a time of the euro’s historical weakness. However, the
company still could not be sure about the exact situation that would happen in the future, so it
relayed on its expectations, fears, and risk. In 2002/03, the results were beneficial for Porsche
and they were expected to be even more successful in the future. Different analysts still believed
that such strategy is risky for the whole company, so its management wished to reconsider it and
decide whether it is truly the best.
Although Porsche’s put option purchasing strategy was often criticized, it has proven to
generate positive outcomes. However, there is a proper reason for such criticism, since it
represented a very expensive and risky strategy. Many analysts believed that the company just
remained lucky than skilled for such strategy. Therefore, Porsche could implement another
valuable strategy that would not leave the whole company exposed to such risks, since future is
always optional and predictions about it are often wrong.

Works Cited:
Moffet, Michael and Petitt S. Barbara. “Porsche Exposed.” Thunderbird School of Global
Management, 24 Apr. 2004. Case Study.
Amadeo, Kimberly. “2 Types of Exchange Rates Explained.” The Balance, The Balance,
22 Apr. 2019, www.thebalance.com/what-are-exchange-rates-3306083.
Pettinger, Tejvan, et al. “Currency Speculation and Exchange Rate.” Economics Help, 25
Jan. 2018, www.economicshelp.org/blog/785/economics/currency-speculation-and-exchange-
rate/.
Kenny, Thomas. “Hedging Foreign Currencies and How It Affects Bonds.” The Balance,
The Balance, 13 Sept. 2019, www.thebalance.com/what-is-currency-hedging-416913.
“Currency Hedging.” Kantox, www.kantox.com/en/glossary/currency-hedging/.