International Corporate Finance: Value Creation with Currency Derivatives in Global Capital Markets, + Website

CHAPTER 18

Managing Economic Exposure

God does not play dice with the universe.

Albert Einstein

The abrupt devaluation of the Argentine peso in January 2002 nearly bankrupted Aerolíneas Argentinas, the country's national air carrier. Argentina's currency board had enshrined the parity between the Argentine peso (ARS) and the U.S. dollar at ARS 1 = US$1 for an entire decade (1991–2002), and when it collapsed, the newly floating Argentine peso rapidly devalued by 200 percent to ARS 3 = $1. As a result, Aerolíneas Argentinas experienced an immediate tripling of its largely U.S. dollar–denominated costs, which consisted primarily of jet fuel expenses, debt financing, and lease payments on airplanes. Unfortunately for Aerolíneas Argentinas, the collapse of the peso induced a deep recession that resulted in a sharp contraction in domestic airline ticket sales as Argentinians' disposable income shrank. Aerolíneas Argentinas—which had been lulled into a false sense of security with the seemingly matched currency denomination of its revenue and cost streams for as long as the ARS 1 = US$1 peg held—was now unable to pass through exploding costs into higher airfares to regain its profitability. It had to seek bankruptcy protection from its creditors.

The sorry tale of Aerolíneas Argentinas is very revealing: It illustrates how a myopic focus on what was apparently a zero short-term and long-term transaction exposure to the U.S. dollar had failed to alert its managers to how the firm's intrinsic ...