Lufthansa
Is it Hedging or Speculating?
Case synopsis
In January 1985, Lufthansa,
under the chairmanship of Heinz
Ruhnau purchased twenty 737
jets from Boeing.
The agreed upon price was
$500 million, payable in US$ on
delivery of the aircrafts in one
year, that is in January 1986.
Case synopsis
The US$ had been rising steadily and rapidly since 1980, and was
approximately DM3.2/$ in January 1985.
Worst case scenario: US$ continues to appreciate.
Herr Ruhnau’s expectations
“Like others at that time, he believed that the US$ had risen about
as far as it was going to go, and would probably begin to fall by the
time January 1986 rolled around.”
Hedging alternatives
Remain uncovered
Full forward cover
Option hedging
Money market hedge
Some combination of the above alternatives
Remain uncovered
It is the maximum risk approach.
If e = DM 2.2/$ by January 1986, the purchase of the jets would be
only DM 1.1 billion.
If e = DM 4/$ the total cost would be DM 2 billion.
Many firms believe that:
uncovered position = currency speculation.
Full forward cover
This approach would have locked in an exchange rate of DM 3.2/$,
with a known final cost of DM 1.6 billion.
Foreign currency options
A put option on the DM at DM 3.2/$, could locked in DM 1.6 billion
plus the cost of the option premium (DM 96 million).
The total cost of the purchase in the event the put was exercised
would be DM 1.696 billion.
Money market hedge
Obtain the $500 million now and hold those funds in an interestbearing account or asset until payment was due.
What ultimately eliminated this alternative for consideration was
that Lufthansa had several covenants that limited the types,
amounts, and currencies of denomination of the debt it could carry
on its balance sheet.
Heinz Ruhnau's decision
Ruhnau covered forward half of the exposure ($250 million) at DM
3.2/$, and left the remaining half uncovered.
Expected cost as of January 1985
Alternative Benchmark
rate
Dollar up
No change
in spot
Dollar down
Uncovered
DM 3.2/$
Cannot tell 
DM 1.6 b
Cannot tell 
Full forward
cover
DM 3.2/$
DM 1.6 b
DM 1.6 b
DM 1.6 b
Partial
forward
cover, 50/50
DM 3.2/$
Cannot tell 
+ DM 0.8 b
DM 1.6 b
Cannot tell 
+ DM 0.8 b
Put options
DM 3.2/$
DM 1.696 b
DM 1.696 b
Cannot tell 
+ DM 69 m
Expected cost as of January 1985
Alternative Benchmark
rate
Dollar up
No change
in spot
Dollar down
Uncovered
DM 3.2/$
Cannot tell 
DM 1.6 b
Cannot tell 
Full forward
cover
DM 3.2/$
DM 1.6 b
DM 1.6 b
DM 1.6 b
Partial
forward
cover, 50/50
DM 3.2/$
Cannot tell 
+ DM 0.8 b
DM 1.6 b
Cannot tell 
+ DM 0.8 b
Put options
DM 3.2/$
DM 1.696 b
DM 1.696 b
Cannot tell 
+ DM 69 m
Expected cost as of January 1985
Alternative
Benchmark
rate
Dollar up
No change
in spot
Dollar down
Uncovered
DM 3.2/$
Cannot tell 
DM 1.6 b
Cannot tell 
Full forward
cover
DM 3.2/$
DM 1.6 b
DM 1.6 b
DM 1.6 b
Partial
forward
cover, 50/50
DM 3.2/$
Cannot tell 
+ DM 0.8 b
DM 1.6 b
Cannot tell 
+ DM 0.8 b
Put options
DM 3.2/$
DM 1.696 b
DM 1.696 b
Cannot tell 
+ DM 69 m
Expected cost as of January 1985
Alternative Benchmark
rate
Dollar up
No change
in spot
Dollar down
Uncovered
DM 3.2/$
Cannot tell 
DM 1.6 b
Cannot tell 
Full forward
cover
DM 3.2/$
DM 1.6 b
DM 1.6 b
DM 1.6 b
Partial
forward
cover,
50/50
DM 3.2/$
Cannot tell 
+ DM 0.8 b
DM 1.6 b
Cannot tell 
+ DM 0.8 b
Put options
DM 3.2/$
DM 1.696 b
DM 1.696 b
Cannot tell 
+ DM 69 m
Expected cost as of January 1985
Alternative
Benchmark
rate
Dollar up
No change
in spot
Dollar down
Uncovered
DM 3.2/$
Cannot tell

DM 1.6 b
Cannot tell 
Full forward
cover
DM 3.2/$
DM 1.6 b
DM 1.6 b
DM 1.6 b
Partial
forward
cover, 50/50
DM 3.2/$
Cannot tell
 + DM 0.8
b
DM 1.6 b
Cannot tell 
+ DM 0.8 b
Put options
DM 3.2/$
DM 1.696 b
DM 1.696 b
Cannot tell 
+ DM 69 m
Outcome
The dollar weakened from DM 3.2/$ to DM 2.3/$.
Outcome: Perfect hindsight
Alternative
Benchmark rate Total DM cost
Uncovered
DM 2.3/$
$1.15 billion
Full forward cover
DM 3.2/$
$1.6 billion
Partial forward cover,
50/50
DM 2.75/$
1.375 billion
Put options
DM 3.2/$ (strike) 1.246 billion
Outcome: Perfect hindsight
Alternative
Benchmark rate Total DM cost
Uncovered
DM 2.3/$
$1.15 billion
Full forward cover
DM 3.2/$
$1.6 billion
Partial forward cover,
50/50
DM 2.75/$
1.375 billion
Put options
DM 3.2/$ (strike) 1.246 billion
Outcome: Perfect hindsight
Alternative
Benchmark rate Total DM cost
Uncovered
DM 2.3/$
$1.15 billion
Full forward cover
DM 3.2/$
$1.6 billion
Partial forward cover,
50/50
DM 2.75/$
1.375 billion
Put options
DM 3.2/$ (strike) 1.246 billion
Outcome: Perfect hindsight
Alternative
Benchmark rate Total DM cost
Uncovered
DM 2.3/$
DM1.15 billion
Full forward cover
DM 3.2/$
DM1.6 billion
Partial forward cover,
50/50
DM 2.75/$
DM1.375
billion
Put options
DM 3.2/$ (strike) DM1.246
billion
The Aftermath
“On February 14, 1986, Heinz Ruhnau was summoned to meet
with Lufthansa's board and with Germany's transportation minister
to explain his supposed speculative management of Lufthansa's
exposure in the purchase of Boeing jets.
Herr Ruhnau was accused of recklessy speculating with
Lufthansa's money, but the speculation was seen as the forward
contract, not the amount of the exposure left uncovered for the full
year.”
Herr Ruhnau was accused of making the following
mistakes:
Purchasing the Boeing aircraft at the wrong time.
Choosing to hedge half of the exposure when he expected the
dollar to fall.
Choosing forward hedging over options
Purchasing Boeing jets at all
What went wrong?
Lufthansa’s board should have chosen DM1.6 b as a benchmark
(DM3.2/$)
Herr Ruhnau expected the dollar to fall; hence, he should have
used option hedging
Concept check #1
If you believe there is a 80% probability that your house will be
destroyed by floods, would you buy insurance or move to another
location?
Concept check #2
You want your exams to be assessed based on:
a. a pre-determined, objective exam key
b. instructor’s inspiration at the time of grading
Conclusions
Expect the exchange rate to move against you? Use forward
hedging.
Expect the exchange rate to move in your favor? Use option
hedging.
The benchmark has to be ex-ante not ex-post.