Embraer and the Wild Ride of the Brazilian Real For many years Brazil was a coun

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Embraer and the Wild Ride of the Brazilian Real For many years Brazil was a country battered by persistently high inflation. As a result, the value of its currency, the real, depreciated steadily against the U.S. dollar. This changed in the early 2000s when the Brazilian government was successful in bringing down annual inflation rates into the ingle digits. Lower inflation, coupled with policies that paved the way for the expansion of the Brazilian economy, resulted in a steady appreciation of the real against the U.S. dollar. In May 2004, 1 real bought $0.3121; by August 2008, 1 real bought $0.65, and appreciation of more than 100 percent. The appreciation of the real against the dollar was a mixed bag for Embraer, the world's largest manufacturer or regional jets of up to 110 seats and one of Brazil's most important industrial companies. Embraer purchases most of the parts that go into its jets, including the engines and electronics, from U.S. manufacturers. As the real appreciated against the dollar, these parts cost less when translated into reals, which benefited Embraer's profit margins. However, the company also prices its aircraft in U.S. dollars, as do all manufacturers in the global market for commercial jet aircraft. SO, as the real appreciated against the dollar. Embraer's dollar revenues were compressed when exchanged back into reals. To try and deal with the impact of currency appreciation on its revenues, in the mid-2000s Embraer started to hedge against future appreciation of the real by buying forward contracts (forward contracts give the holder the right to exchange one currency - in this case dollars - for another - in this casereals - at some point in the future at a predetermined exchange rate). If the real had continued to appreciate, this would have been a great strategy for Embraer because the company could have locked in the rate at which sales made in dollars were exchanged back into reals. Unfortunately for Embraer, as the global financial crisis unfolded in 2008, investors fled to the dollar, which they viewed as a safe haven, and the real depreciated against the dolar. Between August 2008 and November 2008, the value of the real fell by almost 40 percent against the dollar. But for the hedging, this depreciation would have actually increased Embraer's revenues in reals. Embraer, however, had locked itself into a much higher real/dollar exchange rate, and the company was forced to take a $121 million loss on what was essentially a bad currency bet. Since the shock of 2008. Embraer has cut back on currency hedging, and most of its dollar sales and purchases are not hedged. This makes Embraer's sales revenues very sensitive to the real/dollar exchange rate. By 2010, the Brazilian real was once more appreciating against the U.S. dollar, which pressured Embraer's revenues. By 2012, however, the Brazilian economy was stagnating, while inflation was starting to increase again. This led to a sustained fall in the value of the real, which fell from 1 real = $0.644 in July 2011 to 1 real = $0.40 by January 2014, a depreciation of 38 percent. What was bad for the Brazilian currency, however, was good for Embraer, whose stock price speculation that the decline on the real would lead to a boost in Embraer's revenues when expressed in reals.

1. Since 2008 Embraer has significally reduced its dollar hedging operations. Is thsi wise?

2. Between mid-2014 and early 2015 the real depreciated significantly against the U.S. dollar. What do you think the impact was on Embraer?

Explanation / Answer

The decision of reducing the hedging operation is a wise one because US economy is more stable as compared to the Brazil’s economy and hence the fluctuations in real and most of the time dollar outperformed real and even if don’t outperform then also the gain in imports will compensate for the loss during sales (due to exchange rates during imports and sales) but during hedging operation this won’t happen and Embraer will most probably face losses. During mid 2014 to early 2015 real depreciation took place against dollar and because of this depreciation and due to the removal of hedging operations the revenue of Embraer will increase ( they sell in dollars and due to real’s depreciation 1 dollar was equivalent to more real than previous) and there revenue must’ve gone up.

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