Foreign Exchange Hedging Strategies: Singapore Airlines & Qantas Group - Research Paper

Introduction

Foreign exchange hedging strategies entail application of concepts that relate to procedures and rules that are in line with international businesses and investors to protect their profit margins from any volatilities in foreign exchange when trading currencies. Some of the currency methods applied by Singapore Airlines and Qantas Group include:

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Forward Foreign Exchange Contracts

Forward contracts refer to agreements made between two parties in an exchange of two different currencies for a specific time in the future. The contracts occur at a specific date and place stipulated on the spot contract. They help to protect the buyer from any currency price fluctuations.

Singapore Airlines uses forward currency contracts by referring to the current forward prices for contracts that possess similar maturity profiles (SA Annual Report, 2016/17).

Qantas group uses the program when handling its fuel and foreign exchange risks. For the 2016/17 FY, the company positioned itself for a worst-case scenario for a total fuel cost of $3.2B with an 87 percent participation rate in the event of lower fuel prices. This was done with a current forward market price that had a total value of $3.1B for the financial year.

Cross-Currency Swaps

These provide an over-the-counter (OTC) derivative that presents like an agreement between two parties with the aim of exchanging the principal and interest payments in two different denominations.

Singapore Airlines use swap contracts in various ways. According to Singapore Airlines Annual financial report (2016/17), the company uses Jet fuel swap contracts to conduct market-to-market valuations. Other swap options used include cross-currency swap contracts which refer to the market prices for the existing cash flow systems that were pre-agreed with other contract parties during inception of the trade. The Brent-MOPS crack swap contracts and the InterContinental Exchange (ICE) Brent Swap provide references to the available market-to-market values and market information of the swap contracts. The Group hedges the Brent-MOPS crack contracts and the ICE Brent and the ICE Brent futures contract prices and their differential relatives to MOPS prices aid in establishing the market-to-market prices (Singapore Airlines Annual Report 2016/17).

The Qantas group uses the cross-currency swaps to convert the long-term foreign currency borrowings to currencies that the group has more forecast and sufficient surplus in net revenue. This helps to meet the principal and interest obligations that are covered under the swaps (Qantas group annual report 2016). In this case, the long-term borrowings are held in foreign currencies where the group will obtain its surplus revenue. The fair value of interest rates swaps are also used in cash flow hedging in the company by determining the present value of the future contracted cash flows.

Currency Options

A currency option provides a hedging method that companies use to protect themselves from any depreciation of currency below a specified option price.

Singapore Airline's earnings are usually affected by changes in the prices of jet fuel (singaporeair.com, 2018/19). To manage the risk on fuel price, fuel risk management programs that allow for the application of approved instruments that include options and collars aid in hedging the approved range of any anticipated purchases of jet fuel over a specified period. Options contracts are also applied in cash flow hedges.

The Qantas Group applies currency options when managing the foreign exchange risk among other hedging tools such as forward foreign exchange contracts and cross-currency swaps among others. Options and swaps are also applied on gasoil, jet kerosene, and crude oil to hedge their exposure to the movements of aviation fuel in line with the USD price. It considers the crude component of the fuel as a separately measurable and identifiable component in aviation fuel. The process of separately hedging the foreign exchange risk in the total cost of fuel is done using currency options.

Critical Evaluation

Forward Foreign Exchange Contracts

A forward exchange contract is a type of transaction that involves foreign currencies. They are agreements where the involved parties agree to exchange specific currencies at a designated time in the future. They are mainly used to protect the buyer from any currency price fluctuations that may arise in future. The rate of exchange for the contract is specified and fixed for a specific future date that allows the involved parties to easily budget for any future financial projects and know in advance their estimated outcomes in terms of costs and income from the transaction at that specified date in the future (Chen, 2019).

Singapore airlines experience fluctuations in the foreign exchange rate due to its foreign currency that dominates its revenues and expenses. According to the company's annual report (FY 2016/17), the foreign exchange risk accounted for 49.9% of the company's total revenue for the FY 2015/16 and 53.6% of the total operating expenses for the same financial year. The company experiences the largest exposures to the risk from the United States Dollar, Swiss Franc, Euro, New Zealand Dollar, Euro, Japanese Yen, Australian Dollar, Hong Kong Dollar, Indian Rupee, Korean Wong, Chinese Yuan and Malaysian Ringgit (Singapore Airlines FY 2016/17, P 192). The company generates a surplus in all the currencies involved apart from the USD. This is attributed to the fuel costs, capital expenditure and the costs of leasing aircraft since all the costs are basically denominated and payable using the USD. As a result, the company uses the forward foreign exchange contract to manage its risks of foreign exchange exposures through policy matching, receipts, and payments of each of the individual currencies (SIA Annual Report FY 2015/7).

Qantas group uses the forward foreign exchange contracts to hedge a portion of the remaining net revenue on foreign currency expenditure in line with the Qantas Group policy. The net foreign currency expenditure and volume are hedged with specific parameters and any hedging outside the parameters requiring approval by the company board. According to Qantas Group financial report (2015/16), the foreign exchange contracts and options for the year ending 30th June 2016 included hedging of future payments of capital expenditures that amounted to $4 million. The hedging was recognized at fair value and in accordance with the AASB 9.

Cross-Currency Swaps

Cross-currency swaps provide an over-the-counter derivative in the form of an agreement between two parties to exchange the principal and interest payments denominated in two different currencies.

According to the SIA Annual Report FY (2016/17), Singapore Airlines held currency swaps for the principal amounts on the outstanding foreign currency denominations on bonds until December 2017. The hedge was effective on a prospective basis as it led to a net fair value gain of $0.6 million compared to the loss of $4.3 million for FY 2016. Other cross-currency swap contracts are held by the company to hedge the expected future lease commitments in foreign currency risk involving surpluses in JPY, EUR, and USD until August 2021 (SIA Annual Report FY 2018/19). The hedges were assessed as at 31 March 2019 and found to be effective with a net fair value loss of $1.4 million compared to $10.8 million profit for FY 2018 (SIA Annual Report FY 2018/19).

Qantas group uses the cross-currency swaps to convert the long-term borrowings on foreign currencies to currencies that the Qantas group can forecast and obtain sufficient surplus net revenue to get back the principal and interest obligations covered by the swaps (Qantas Annual Report FY 2016/17).

Currency Options

Companies use foreign currency options to hedge against uncertain future cash flows in foreign currency.

Singapore Airlines manages its fuel price risk by using option and collar contracts and hedging up to 20 quarters forward using jet fuel option contracts (SIA Annual Report FY 2016/17). It uses the option contracts to hedge a portion of its future exposure to foreign exchange. The contracts enable the company to sell the currencies at predetermined option rates, either through USD or SGD while depending on the forecast requirements.

Qantas group uses currency options to hedge a portion of the remaining net foreign currency expenditure or revenue in line with the Group's policy. The net foreign currency expenditure and revenues out of two years may also be hedged with specific parameters (Qantas Annual Report FY 2016/17). The currency options are also used to separately hedge the foreign exchange risk in the total cost of fuel.

To conclude, airlines conduct hedging to control their operational costs with a specific focus on fuel costs among other expenses. As international companies, they are subjected to financial risks that include interest rates, liquidity, credit risks, fuel price risks, and foreign exchange. These risks are innate to the airline business and portfolio. However, foreign exchange risk is unavoidable due to the multinational nature of the airline industry. The risk is considerably mitigated through hedging techniques that include the use of forward foreign exchange contracts, currency swaps, and currency options. These hedging systems have been appropriately applied in the airline companies under consideration, i.e., Singapore Airlines and Qantas Group. The currency forwards effectively hedge the currency risk, currency swaps enable for payment of the principal and interest of a loan in one currency and the interest in another currency and the currency options provide feasible alternative to hedge exchange rate risk. These techniques are appropriately implemented by the companies with the aim of moderating the effects of volatilities on its financial performance via using derivatives to hedge the specific exposures. These derivatives used for risk management purposes do not expose the group to market risk because the gains and losses on them offset the gains and losses that match the asset, liability, expenses, and revenues that are being hedged. The overall risk management approaches applied by both companies aim at moderating the effects of the volatilities on its financial performance via application of derivatives to hedge the specific exposures. The idea that airlines profit from long-term hedging practices does not cross with the reasons behind hedging. Airlines do not hedge to improve profits but to reduce the swings in profits. This means that they hedge to make profits remain closer to the average.

Bibliography

Qantas.com.au. (2016). Qantas Annual Report FY 2015/16. Available at: https://www.qantas.com.au/infodetail/about/corporateGovernance/2016AnnualReport.pdf

Singaporeair.com. (2019). Singapore Airlines Annual Report FY 2018/19. Available at: https://www.singaporeair.com/saar5/pdf/Investor-Relations/Annual-Report/annualreport1819.pdf

Singaporeair.com. (2017). Singapore Airlines Annual Report FY 2016/7. Available at: https://www.singaporeair.com/saar5/pdf/Investor-Relations/Annual-Report/annualreport1617.pdf