1. Lufthansa Case Study

2. Synopsis
• Lufthansa, purchased twenty 737 Boeing aircraft
in January of 1985 for $500 million.
• The payment was due in January of 1986 upon
delivery of the aircraft from the U.S.
manufacturer.
• At the time of the purchase, the U.S. dollar was
at a record high versus the Deutschemark, and
had been steadily appreciating against the
Deutschemark for 5 years.
• The CEO of Lufthansa, Herr Heinz Ruhnau, was
responsible for determining what hedging if any
would be use.

3. Focus of The Case
• The focal point of of this case is the managerial
decision-making, the formation of expectations,
and the value and leadership of senior
management.
• Arguing over what Herr Heinz Ruhnau did in
retrospect and what we may think he should
have done is not the point.
• The more general lesson is whether the firms
best interests are found in accepting open
uncovered positions or not.

4. Question 1
• T dollar was “high” at this point, and therefore
the decision to purchase now seems to be a bit
late.
• Yet, given the trend in the movement of the DM/
$ rate over the previous years, it appears (using
the graphic available to Herr Heinz Ruhnau in
January 1985, Exhibit 2), that postponing the
purchase would only result in a higher dollar and
therefore a higher expense.

5. Question 2
• Should Herr Ruhnau have gone “whole hog”?
• There are two views
• Since he is paid the big bucks to make the big decisions,
and if he believed the dollar was about to fall he should
have remained completely uncovered.
• Or, on the contrary, he is also paid the big bucks to
pursue Lufthansa’s strategic future, and that does not
include the gambling on exchange rate movements.
• Both views are valid, however, that the 50/50 result is
difficult to defend itself.
• (This is equivalent to covering one exposure and leaving
an identical exposure completely uncovered; a
somewhat schizophrenic “view” on the direction of
exchange rate movements.)

6. Question 3
• The purchase of a put option would have indeed
provided solid insurance. Yet, it is difficult to explain why
one should spend millions on the purchase of protection
which one hopes not to use.
• This is a flawed argument as it is obvious if we extend it
to any insurance policy. However, it has real meaning in
many boardrooms even today.
• As a matter of fact, few private firms were actually using
currency options for risk management in 1985 when this
situation arose.
• Herr Ruhnau could have purchased an out-of-the-money
put option on Deutschemarks to reduce the premium
paid.
• He could also have purchased a collar, i.e., sold a call to
finance the purchase of the put option hedge on
Deutschemarks to reduce the premium further.

7. Question4
• 4. Why Boeing instead of Airbus?
• We have no information for a factual
evaluation of this issue.
• But it is important to notice that the choice
of purchase and the terms of a purchase
give rise to the exposure itself.

8. Other Points
• The initial decision is made with a highly overvalued
dollar but a trend line which was hard to argue with.
What do you expect, and which hedging alternative
would you pick?
• With the 50/50 hedge position he cannot possibly
win. One side’s gains will always offset the losses on the
other.
• Why did Ruhnau not change his position when it became
clear that the dollar had indeed peaked and was on its
way back down?
• This may be the most legitimate criticism of Herr
Ruhnau’s management: the failure to re-position the
hedge when new information is incontrovertible.
Although this would not recoup previous exchange rate
losses, it would allow Lufthansa to enjoy any further drop
in the value of the dollar (or suffer any increases if the
value of the dollar turned once again).