Financial Derivatives Trading of EasyJet

Part A

1 Developing a concrete risk management framework on basis of financial derivatives and advanced hedging strategies of EasyJet

EasyJet is an airline company is referred as British low cost carrier airline whose headquarter is at London Luton Airport. Its operations is in domestic and international scheduled services with some specific 820 routes as in more than 30 countries. It is directly listed on London Stock exchange and it is also a constituent of FTSE 100 indices. It is also known as low cost passenger airline whose operations are throughout Unite kingdom and mainland Europe. Usually its sells it tickets via its website (Hudson, 2017). It operates along with its subsidiaries in Europe. The organization is also involved in leasing and trading aircraft along with various provisions of services of graphic design. Its financial performance is fluctuating from year to year due to various reasons which are identified in stated article.

Interpretation: The above graph is depicting Financial performance of EasyJet plc for consecutive five years, in which it can be easily viewed that there is presence of major fluctuations. The sales of organization are increasing but due to increase in fuel and currency cost it is not able to convert their sales into margin in efficient manner (EasyJet plc, 2018). The organization has partners such as WDL Aviation, SmartLynx and Titan Airways in very systematic manner but do raise in currency and fuel cost, they have identified decrement in margin (Bacha, 2017).

The organization must utilizes financial derivatives for managing its whole exposure in context of variation in fuel price, interest rate and foreign exchange rate variations. For mitigating with interest rate risk inherent in UK and other countries floating rate debt and its investment, the firm must create ability for entering in forward interest rate agreements with short term maturity or it should be not more than 18 months. Usually interest rate risk is directly affecting short term investments and along with variable rate debt instruments as it directly changed by alterations in LIBOR. The swap agreements should be properly utilised as they are built in context of lease and loan agreements.

The above specified graph is depicting monthly price of fuel in London as in 2014 it was declining, but in 2015 it started raising again but then too it falls in same year. There was sudden rise in 2017 January which had impacted AirJet's financial in huge aspect, as it was generating turnover but to its operation cost it had not raised its profits. So for managing its exposure organization must adopt systematic hedging strategy for hedging its position up to 50% of its consumption which should ensure about 1 year period. In the same series, contracts should be hedged must be entered after October as it comprises hedge accounting on basis of financial statement of next fiscal year. This will be depicting loss on hedged contracts which was summed up at fuel cost. In the ending of fiscal year, organization must use collor option structure in place for hedging 7.1 million tonnes as compared to 6.5 million tonnes from 2017 to 2016 year respectively. The overall emissions are due because of expansion of operations of easyJet. There was lack in context of liquidity, organization must be able to hedge along with its fuel based contracts in context of short term. The effective hedges must be applicable by entering into contracts of heating and crude oil (Rebentrost, Gupt and Bromley, 2018).

EasyJet is considering cost of fuel as second largest expense in its financial statement. There should be hedging of fuel price by using various commodity and financial instruments such as collars, futures, options and forward as well. In the same series, specific portion of expected jet fuel cost should be hedged in future so it must enter in derivative contract from time to time. For the volatility of fuel price, swaps and options are considered as best exposure as it can also use fixed price and cap arrangements. Already EasyJet has mitigated risk by US dollar exchange rate but that was due to interest rate risk but there was absence of Derivative risk as in its history it got profit of 12.3 million in fiscal 2005. It was through optimising limited no, of instruments for hedging for zero cost collars and forwards for hedging against fluctuations of fuel price. According to this policy, hedging more than 80% of fuel which is predicted as consumption of 1 year in advance and to very lesser extent it should be predicted up to 3 year in advance.

For managing volatility of foreign risk organization must be able to enter in foreign exchange forward contracts and currency swaps. As there should be presence of currency swap from third party until the termination. In airline company, usually all transactions are denominated in foreign currency which helps in generating surplus and they should be capable tomatch receipts and payments of every currency so it is first step for mitigating exposure of foreign currency. The surplus which has been gained of that foreign currency should be sold in context of spot or forward rate for US dollars or any other. The forward foreign exchange contracts are usually for utilising to cover revenues of short term future and along with its all expenses must be hedged against currency fluctuations. EasyJet must be able to manage exposure of fluctuations of currency which is originating from denominated purchases of especially flight equipments and foreign accounts payable and recievable as well. It should be directly able to manage hedging via forward foreign exchange contracts, currency swaps and options.

EasyJet is operating globally and is generating revenues and expenses from operations in multitude of specific currencies. Mostly foreign currencies are exposed to USD, Swiss Franc, EUR, Hong Kong dollar, Indian rupees, Malaysian Ringgit, UK sterling pound and Koran won. As discussed above receipts and payments should be matched and surplus should be converted. The contract should be able to settle from range of one month to 12 months for purpose of hedging but not in favour of exposure of foreign exchange. The most popular strategy should be adopted such as cross currency swap agreements for exchanging loans which are bearing floating rates of interests. The exception of US dollar, organization had managed this risk as its revenues and expenses which exclude aircraft lease, interest expense, fuel maintenance cost and insurance which is denominated in Sterling and Euro currency. As EasyJet does not use any exposure for managing risk but because of high cost products such as payments of capital lease, mortgage and proceeds along with sale of aircraft it has gained huge liability element which is denominated in US dollar (Infante and Sorvillo, 2017). Students can also get the best and affordable College Assignment Help from our writers.

2 Describing the contribution of financial derivatives which is triggering financial crisis of 2008

Derivatives are those monetary securities which are based upon some security like stocks and bonds. Financial derivatives are those legal agreements that derives its value from financial instruments. In this the seller agrees to sell the financial instruments in the particular date at a particular time. Basically these are used for the commodities like gold, oil, gasoline etc. the financial derivatives are mostly describes for two commodities (I)forward commitments or contingent claims. Financial derivatives used to protect one from financial losses and to reduce risk. It opens many doors for investors. Financial derivatives creates the more chances ofupcoming cash inflow or outflow. It permits the company to exchange the assets on a upcoming date at a price setout for today to have their future earning more quickly. Financial derivatives are based upon some instruments that are discussed as under-

1. FORWARDS -it is a legal agreement with two or more parties where the process paying of remittanceis done at a particularpoint of time in the future in present per-determined time. It is a morecustomized form of future contracts. That is why the delivery time and amount are personalized according to the needs of buyers and sellers. It is a cash transaction.

2. FUTURES - futures are those legal agreements to exchange the assetson a future date at a price specified today. Futures are the equalize legal agreement between two parties.It gives right to the purchaser to buy or sell the future contracts. Future works on the same periphery as the option do but the underlying security is different.

3. OPTIONS - It is an agreement enforceable by law among two parties to purchase or sell securities at a given price. Mainly it is used in trade stock option but can be used for other investment as well. The call option has been purchased by an investor then, when only he can purchase the right to takean asset at a givenprice on a particular time limit The option contracts also specify the due date.InEuropean option , not before the maturity date , the owner has the power to havethe sale to take place , and inAmerican option the owner can require the sale to gave up to duedate (Kahalé, 2017).

4. WARRANTS - Mostly the short dated options ere used but there lies in long dated option which are rarely used by investors are termed as warrants.

5. SWAPS - In swaps the investors have opportunity to exchange the benefits of their security with each other. For example- one party may have a bond for fixed interest , but in a line of a business they have a opportunity to prefer a varying interest rate so if they want they can perfertowards swap contract..

It has major contribution of financial derivatives in triggering the financial crisis in 2008 as financial crisis has taken place when banks are able to create too much money , to quickly and increased the prices of houses tosurmise on the financial bank.Most of the time bank creates the Loan and freshmoney introduces to the market in this global crisis . They have debt to the economy the certain amount of money they have doubled in last 7 years.It is told by many of us about the high price of the houses . It was correct that prices of houses were increased by the hundreds of billions of pounds of fresh money that introduced by the bank in the year before financial crisis. The credit derivatives had played very important role in triggering the financial crisis. The values whose derives on the credit risk on an underlying bond , loan or other financial asset are termed as financial derivatives.The financial derivatives to the some extent effects the financial crisis . Since the very big loss has been suffered by the financial institution for example Bear Stern, Lehman Brothers, AIG , etc.financial crisis has been caused the excessive derivatives transactions. Many people gave their conclusion that crisis is taken birth from the derivative transaction.

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After having a loan between local bank and homeowners , the loans are sold by them changing into securities ( securitization ) This borrowing powers combines the mortgage with other mortgages into a mortgage pool. This has convertedinto mortgaged backed securities , later they have been sold to the asset backed bond after combining them with credit loan , student loan , auto loan etc.Furthermore the asset based bonds were segmented , ranched and sold to the collaterized debt obligation. To fulfill specific risk prefrences of investors CDOs has creatively constructed with different risk ratinggs.

Then the credit default swap was the fresh to introduced in financial derivatives instruments which also played a big role to thestern of the crisis. In 1990s credit default swap has taken birth to provide option to hedge and speculate their credit.

Derivates ere designed to explore or to provide a greater financial resources to the mortgage market (Bryan and Rafferty, 2014).

Since the derivatives eventually are traded on the basisof underlying assets, any inappropriate fall in the value of underlying assets can cause the crash in financial markets.

Due to the absense of regulation the derivatives had changed the whole scenario in causing the crisis as derivatives mere traded as over the counter segment that is they are not the part of subject to regulation that means , that the hard and fast rule could play by the bank and allow their own rule for derivative trading outside concern of regulators.

By concluding it , the crisis in sub prime mortgage loan in the US has triggered the global financial crisis in 2008. Mixture of lowestinterest rate, intricate credit derivatives instruments, and excessive risks actions with incentives packages by the finance providing institution had brought expansion of sub prime security long term borrowings. Therefore, the incline value of real estate combine with the permament rise of the rate of interest had drop many sub prime borrowings in default. This enormous situation has made huge loss to the real estate industry of United States.