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FRM Part I · FRM Exam Part I · How Do Firms Manage Financial Risk?

A US airline's fuel costs are in USD, but it earns a large share of its revenue in euros from European ticket sales. Which statement best describes the firm's exposure and a suitable approach to managing it?

The airline has economic exposure to a weaker euro because euro revenue is set against dollar costs. It can be reduced with natural hedges, such as euro-denominated costs, operations or financing, alongside financial hedges where suitable.

  1. AIt faces economic exposure to a falling euro, which can be partly offset by euro-denominated costs or financingCorrect
  2. BIt faces only translation exposure, which can be eliminated by forward contracts on each ticket
  3. CIt faces no currency exposure because fuel is priced in USD
  4. DIt faces transaction exposure only on fuel purchases, which a euro receivable hedges

Explanation

Euro revenue against USD costs means operating cash flows fall in dollar terms if the euro weakens, which is economic (operating) exposure. Natural hedges such as euro-denominated costs or debt reduce it. Fuel being priced in USD does not remove the revenue-side exposure.

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