Hedging Currency Risks at AIFS

Christopher Archer-Lock, London-based controller for student exchange organization American Institute for Foreign Study (AIFS) talked almost daily with his Boston-based counterpart, Becky Tabaczynski, CFO for the groups high school travel division ACIS. On this day in early July, 2004, their daily phone call had been especially invigorating.

As often before, they had discussed foreign exchange hedging, an area of key importance for the company. AIFS received most of its revenues in American Dollars (USD), but incurred its costs in other currencies, primarily Euros (EUR) and British Pounds (GBP). The currency mismatch was natural given AIFSs business: it organized educational and cultural exchange programs throughout the world. Two of AIFSs major divisions served American students traveling abroad. The Study Abroad College division, where Archer-Lock was controller and treasurer, sent college-age students to universities worldwide for semester-long programs, and the High School Travel division, whose finances Tabaczynski managed, organized 1-4 week trips for high school students and their teachers.

Currency hedging helped AIFS protect its bottom line from damaging exchange rate changes. Using currency forward contracts and currency options (Appendix 1 summarizes currency instruments). AIFS hedged its future cost commitments up to two years in advance. The problem was that the hedge had to be put in place before AIFS had completed its sales cycle, and before it knew exactly how much foreign currency it needed. The dilemma meant that Archer-Lock and Tabaczynski frequently discussed two points. First, what percentage of the expected costs should they cover? Currently, AIFS covered 100%. Second, in what proportions should AIFS use forward contracts and options? Today, Tabaczynski had promised Archer-Lock to put together scenarios for how changes in sales and exchange rates could affect the company. He was eager to see what she meant.

AIFS Activities and Business Model

Through its family of companies, AIFS sent more than 50,000 students each year on academic and cultural exchange programs worldwide. Founded in the U.S. in 1964 by Sir Cyril Taylor (HBS MBA 1961) the group had annual revenues close to $200 million. Two of the groups main divisions focused on Americans traveling abroad:

The College division organized study abroad programs for more than 5,000 American university-aged students during the academic year (Academic Year and Semester, AYS) or the summer (College Summer School, CSS.) All courses were for academic credit, with most participants traveling to Europe, and a significant portion to the United Kingdom. Countries with study programs included Australia, Austria, the Czech Republic, France, Italy, Russia, South Africa and Spain.

The Boston-based High School Travel division had been founded in 1978 as the American Council for International Studies (ACIS) and organized chaperoned educational travel for about 20,000 high school students and teachers annually. The groups traveled on 1- to 4-week educational trips to Europe, China, Mexico, Africa, Australia and the Americas. For most participants, these trips were their first exposure to foreign countries, and so AIFS organized the whole trip: airfare, transportation, hotels, tour manager, guides etc.

Overall, the College division had higher margins than the low margin/high volume operations of the ACIS division. ACIS was also more exposed to world events than the College division. High school travelers reacted immediately to news of war, terrorism or political uncertainty. Sales could drop up to 60% on such news. In the last 25 years, four events had led to such drops in ACIS sales: the 1986 terrorism acts, the 1991 Gulf War, the 2001 September 11 attacks and the 2003 Iraq war.

AIFS also ran several other programs, such as an Au Pair division which annually placed 4,000 young people in American homes to assist with child care, and the Camp America division, which placed 10,000 young people as camp leaders in USA summer camps. AIFS also arranged Academic Year in America (AYA) for students wanting to study in the U.S.

Catalogs, Guarantees and Pricing

By and large, AIFSs business was catalog-based. The College division distributed two main catalogs per year (one Summer and one Fall/Spring) and the High School division had one main Fall catalog, with several smaller catalogs distributed throughout the year. A key feature was that AIFS guaranteed that its prices would not change before the next catalog, even if world events altered AIFSs cost base. Although the idea often came up for discussion among AIFS management, it was always agreed that it would be hard to abandon the notion of guaranteed prices. The primary customer base (which was not the students, who changed from year to year, but their teachers and academic advisors) based their loyalty to AIFS on the fact that there would be no price surprises.

When pricing the programs, both divisions took into account their cost base, competitive pricing and also the hedging activities. Their pricing schedules were, however, different.

College Pricing The College worked on an academic planning year, from July 1 to June 30. Prices for any given year had to be set by June 30 the previous year. This meant that now in early July 2004, Archer-Lock had just finalized the prices for the College divisions Summer 2005 and Fall 2005/Spring 2006 catalogs. During the year, Archer-Lock met regularly with marketing and operations managers, to discuss sales forecasts and events that might affect sales. In addition, these managers put out weekly sales forecasts, on which Archer-Lock could base his hedging activities.

High School Travel Pricing Combining tours, seasons and departure gateways, the ACIS catalog contained about 35,000 prices. Tabaczynski set these on a calendar year basis, January to December. One of her main goals was to see that ACIS followed a strategy of slow, but steady price increases year by year. She explained,

We found that if we increased our own prices $200 from one year to another, the market reacted. So to avoid sudden price hikes, we instead raise prices in much smaller amounts, a little each year. Interestingly, if we become $200 more expensive than the competition, our customers dont seem to care. We have a very loyal customer base: over 70% of our teachers are returning customers.

Hedging at AIFS

At AIFS, Tabaczynski and Archer-Lock used currency hedging to help them manage three types of risk. First was the bottom-line risk, or the risk that an adverse change in exchange rates could increase the cost base. Explained Tabaczynski, Say you have costs of EUR 20 million and that we set our catalog prices at parity with the dollar. Then the dollar goes to 1.30! Were now talking 30% of EUR 20 million... Its a move that could take you out of business. Second was the volume risk, since foreign currency was bought based on projected sales volumes, which would differ from final sales volumes. Third was the competitive pricing risk, since no matter how currencies fluctuated, the AIFS price guarantee meant it could not transfer rate changes into price increases. Naturally, the competitive risk was closely link to the other risks, especially the bottom line risk.

Hedging activities normally started about six months prior to a main pricing date. For the College division, this meant that hedging normally began in earnest in January. Figure 1 shows a sample timeline for pricing as well as hedging for the College division.

4. Assume that you are the CFO of AIFS and is considering going public and issuing equity in the New York Stock Exchange (NYSE).

a) Provide two reasons why this might be a good decision?

b) What is your primary social responsibility if your firm goes public?

c) AIFS is thinking about making an investment in New Zealand. AIFS venturing into New Zealand may result in the loss of employment for some hard-working local employees (there will be a shift in some jobs overseas). How will this information affect your decision making?