Question

1. What were the key components of Laker Airways' operating exposure?
2. What options did it have to hedge its operating exposure?
3. Could Laker have hedged its ''natural'' dollar liability exposure?
4. Should Laker have financed its purchase of DC 10 aircraft by borrowing sterling from a British bank rather than using the dollar-denominated financing supplied by McDonnell Douglas and the Eximbank? Consider the fact that Eximbank, a U.S. government agency, subsidized this financing in order to promote U.S. exports.

The crash of Sir Freddie Laker's Skytrain had little to do with the failure of its navigational equipment or its landing gear; indeed, it can largely be attributed to misguided management decisions. Laker's management erred in selecting the financing mode for the acquisition of the aircraft fleet that would accommodate the booming transatlantic business spearheaded by Sir Freddie's sound concept of a ''no-frill, low-fare, stand-by'' air travel package.
In 1981, Laker was a highly leveraged firm with a debt of more than $400 million. The debt resulted from the financing provided by the U.S. Eximbank and the U.S. aircraft manufacturer McDonnell Douglas. As most major airlines do, Laker Airways incurred three major categories of cost: (1) fuel, typically paid for in U.S. dollars (even though the United Kingdom is more than self-sufficient in oil); (2) operating costs incurred in sterling (administrative expenses and salaries), but with a nonnegligible dollar cost component (advertising and booking in the United States); and (3) financing costs from the purchase of U.S.-made aircraft, denominated in dollars. Revenues accruing from the sale of transatlantic airfare were about evenly divided between sterling and dollars. The dollar fares, however, were based on the assumption of a rate of $2.25 to the pound. The imbalance in the currency denomination of cash flows (dollar-denominated cash outflows far exceeding dollar-denominated cash inflows) left Laker vulnerable to a sterling depreciation below the budgeted exchange rate of £1 = $2.25. Indeed, the dramatic plunge of the exchange rate to £1 = $1.60 over the 1981 to 1982 period brought Laker Airways to default.



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  • CreatedJune 27, 2014
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