Essay on Research

3493 Words Sep 24th, 2013 14 Pages
Risk Management Analysis for Air NZ

Abstract
Recent financial theories argued firms can increase their values through hedging by reducing taxable income, agency cost and the cost of financial distress. This report provides a qualitative and quantitative analysis of corporate risk management for the company Air New Zealand. We uses a time series OLS regression model. The fair value of derivatives is used as dependent variable to measure the extent of financial instrument usage. The result shows that the use of derivatives by Air NZ fails to add value to the company.

FINA781 Report Page 1

1. Introduction
Air New Zealand Limited is the national airline and flag carrier of New Zealand. Based in Auckland, New Zealand, the airline
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Jet fuel prices risk: A major component of the operating cost for Air NZ is from jet fuel price which is approximately 15% of the overall costs. According to Carter, Rogers and Simkins (2004) and Loudon (2004) fuel price changes are negatively correlated to cash flows and stock returns of Airlines including the case of Air NZ. Comparatively, an increase in fuel cost can cause dramatically loss on profit as most other expenses are long term fixed such as planes, personal, etc. Thus, airlines have a few options: Increase fuel efficiency of their fleet, pass on the increase of costs to their customers or use hedging instruments to control their losses.
FINA781 Report Page 2

However, a complication is that when airlines need fuel price hedge the most – on the edge of bankruptcy – they do not have the liquidity to buy oil futures as they can’t provide the margin requirements; they could buy options though, but again this costs cash, increasing today’s cash flow risk to avoid potential future risk. This was argued by Weiss and Maher (2009) “financial leverage and derivatives used to protect from fuel price volatility are insignificantly associated with the hedging rank”.

2.2. Foreign Currency Risk: Exchange rate risk is equally important to manage because it is related to Air NZ profitability (Loudon, 2004). Exchange rates influence the tourist numbers both internationally and domestically, it also influences the revenue and

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