Question

The opening case describes the efforts by Brazilian aircraft maker Embraer to limit the impact of changing exchange rates on its revenues. Embraer is exposed to exchange rate fluctuations because the company prices its aircraft in U.S. dollars and then translates its revenues back into Brazilian reals. The company was negatively impacted in the mid-2002s by the appreciation of the real versus the dollar and later when efforts to minimize its exposure were foiled by the 2008 global financial crisis.

a) Brazilian aircraft maker Embraer has been negatively impacted not only by its exposure to changing exchange rates, but also by its attempts to limit its exposure through the use of forward contracts. What options other than forward contracts might Embraer have used to limit its foreign exchange rate exposure?

b) What does Embraer’s experience tell you about the forward market? Could the company’s losses in 2008 have been prevented? Do you agree with Embraer’s decisions to stop using forward contracts?

Answer 1

(a): The fall in exchange rate when compared to U.S. dollars has more or less impacted all industries. In this case, Embraer has under taken the appreciation in value of real by participating in hedging against its revenue gain in to real value instead of U.S. dollars. This method is considered unsafe because the U.S. dollars have appreciated and/or depreciated depending on economic factors. By putting a bet on real value money is going to be appreciated more than U.S. dollars are the least option that a big manufacture like Embraer should do.

One of the options that Embraer can peruse is to be flexible and act upon the exchanging value in short period. If real has appreciated in value, Embraer can buy more parts from U.S. so as to be able to gain some profits because of the exchange rate gap. And when real value is depreciated, Embraer can try to stimulate more sales to U.S. market.  

Secondly when receipts and installments are in a broad form and range of monetary forms, transaction exposure is certainly depleted and slowly diminished. Embraer can switch or swap out the currency which will keep Embraer away from the known hazards related to a similar credit. They could also consider cross hedging which is a defense made with money that the value is similar with the estimated value of the money in where the receivable is assigned to.

(b): Embraer’s experience tells us that the forward market is a rather difficult one to sustain for a company. Their experience was a quite negative one that could have been avoided if they had not stepped into the forwards market in the beginning and chose many other options. The company’s losses could have been prevented in 2008 if they made better decisions and opted for a way out of the forward market quicker.

The downfall in financial market has greatly affected all industries. After experiencing the loss in 2008, Embraer should have taken extra precaution in betting with its currency and should not have taken too much risk on the currency exchange. The loss could possibly be limited if Embraer had not betted all its returned revenue in those transaction.

They can still participate in hedging, but should do so with extra precaution and invest heavily in economic trend. Thus I will not agree with Embraer’s decisions to stop using forward contracts.