THis question is quite challenging.....it's from CFA/FRM sample questionsA European airline has lease a new jumbo jet from US valued at $200 millions. The funding is with 6-month USD Libor. The airline has exposure to jet fuel and USD Libor volatility.(a) Does the airline have EUR/USD exposure?(b) Show how the airline can hedge its USD Libor exposure. Suggest two ways of doing this.(c) Discuss how exposure to jet fuel costs can be hedged. Suggest two ways of doing this. (d) Now conside USD-cap. THis instrument is expensive. How can you reduce its cost by adding a proper barrier that pplies to jet fuel prices.

(a) Is this question asking if the firm has exchange rate exposure? If all its cashflows are in Euro, then definitely.(b) Obvious way is to enter a swap as the fixed payee. That would be a perfect hedge, so I'm not sure why you would consider something else. If they had specific hedging interests (wanted to hedge against LIBOR above, say 7%), then they could buy a cap or some other OTC derivative. They could hedge with swaptions as well if they like. (c) Does entering into a forward or a future contract count as two different ways? (d) I don't think I understand this question.

a>There will be a EURUSD exposure if all revenues are in EUR.b>It can simply get out of the LIBOR exposure by swapping into fixed EUR rates.Or it can buy a collar if its costs permit.c>Hedging Jet fuel costs means only booking forwards or getting into a situation where it can pass on all jet fuel price hikes to the customers !!!d>The question is asking in whiuch situation the comapny can afford to pay away alittle on interest costs from other sources of lower costs.THis will happen if jet fuel prices fall .So set a barrier on the cap where the cap knocks out for the period if fuel is cheaper than a the barrier.Of course this assumes the company has not covered itself forward ion the fuel market already.I guess the fule risk will be large enough for that not to have been done to some extent.Thanks.

QuoteOriginally posted by: pcga>There will be a EURUSD exposure if all revenues are in EUR.b>It can simply get out of the LIBOR exposure by swapping into fixed EUR rates.Or it can buy a collar if its costs permit.c>Hedging Jet fuel costs means only booking forwards or getting into a situation where it can pass on all jet fuel price hikes to the customers !!!d>The question is asking in whiuch situation the comapny can afford to pay away alittle on interest costs from other sources of lower costs.THis will happen if jet fuel prices fall .So set a barrier on the cap where the cap knocks out for the period if fuel is cheaper than a the barrier.Of course this assumes the company has not covered itself forward ion the fuel market already.I guess the fule risk will be large enough for that not to have been done to some extent.Thanks.to c ) I think optinos are surely another option right?I think your comments are very helpful