Lufthansa

Lufthansa

Introduction:

Lufthansa was launched through the buying of 737 jets from Boeing. They were the first one's to do so and because of this they are now the leading airline out of Germany (Wikipedia, 1). "Lufthansa operates more than 300 aircraft and employs nearly 100,000 people world-wide. In 2005, 51.3 million passengers flew with Lufthansa (Wikipedia, 1)."
When the jets were bought in 1985 for $500,000,000 it was considered a huge mistake. Since Lufthansa was just breaking into the business buying the planes from the U.S when the exchange rate was at its highest DM3.2/$ it was considered poor judgment. The man responsible for this decision Herr Heinz Ruhnau cost his company millions of dollars because of several poor decisions.

Reasons for Fired:

Herr Heinz Ruhnau had good intentions in his attempt to buy the Boeing aircraft but he overlooked several key factors. As a chairman for Lufthansa he should have thoroughly considered all factors involved with purchasing a plane.

1.) Herr Heinz Ruhnau had such a strong gut feeling, but it was based on no hard evidence, that the U.S exchange rate was going to drop that he should have postponed buying the planes until after the rate had actually dropped in order to save the company from losing money based on speculation.

2.) By not considering the financial risk he was putting the company in by purchasing a plane from their biggest competitor he potentially cut into the company's profits.

3.) Since he did purchase the planes, regardless of any feelings he had about dropping exchange rates, it was only speculation so he should have put options on the money in order to save the company from higher losses.

Alternative Outcomes:
There were five possible Hedging Alternatives, including the Partial Forward cover option that Ruhnau chose.
1.) First is to remain uncovered which the riskiest option is allowing the company to de open to the gain or lose of money depending on the volatile U.S exchange rate. In the end it would have left Lufthansa paying 1,150,000,000, while the lowest amount still to risky of a decision.

2.) Second would be to apply full forward cover that would allow the company to buy forward contracts for the entire amount and therefore eliminate all risk. This option would have caused to pay 1,600,000,000 dollars because they had locked in the current exchange rate and would not reap the benefits of the lowered rate.

3.) The next alternative would be Foreign Currency Options this would have caused them to buy put options and let them expire then purchasing the dollars for a lesser amount in the spot market. This option would have cost them 1,246,000,000. Although it had some level of risk is the most probable option and would have most benefited the company.

4.) The final alternative is the Buy Dollars Now option which would have required them to have all the money now and hold it until payment is due. Lufthansa could not even consider this option because it had strict covenants in place, that excluding them from eligible from participating.

Justification:

The following justifications Ruhnau could have for keeping his job are as follows:

1.) He bought the jets assuming the price of the U.S. dollar would drop causing the amount owed on the jets to decrease.

2.) He only covered half of the jets because he believed regardless of a drop in U.S currency leaving the money completely uncovered would be to risky. This would allow the company to reduce the amount of available risk if the dollar continued to rise.

3.) By Lufthansa breaking into the jet business they would be able to provide competition against Airbus's monopolized market.

4.) Although many people believed he should have put options on the money. He justified it with the fact they were relatively new and required a large up-front premium.

Conclusion:

Regardless of Ruhnau's intentions only covering half of the money was the most improbable solution. If the U.S. dollar had not dropped the company would have been out a large sum of money, and with it dropping they still ended up paying 129 million more than if they had just put options on the entire amount. A combination of poor judgment and lack of research shows the incompetence of Ruhnau and the reason he should be fired. Although they are now the leading airline in Germany keeping a man with Rehnau's lack of discretion on their team may have led to deterioration of the company.

Lufthansa 7.9 of 10 on the basis of 1023 Review.