Risks ExposureCredit Risks – Portfolio Concentration RiskUnlimited Airway has also invested in a substantial amount of bonds issued by one of these airlines, Great Flight. This means Unlimited Airway has poor diversification, and is exposed to industry Concentration Risk.Both companies are in the same aviation sector which is very dependent on the economy and prices of crude oil. Therefore, there is a risk of incurring heavy losses due to economic crisis and fluctuation of crude oil prices.Crude Oil is one of the key factors Aviation is dependent on. The fuel costs comprise of a large part of an airline’s operating cost. Increase in price of Crude Oil will result in Higher Operating Cost ? Lesser Profit/Loss. However, Decrease in price of Crude Oil Will Lessen Operating Cost ? More Profit, and Increasing Airline Capacity ? Might result in higher expenses when the Oil prices recover.
When economic crisis occurs, Aviation being one of the main pillars of global economy, will get affected. As Aviation is the main source of transportation throughout the world, the industry will experience negative growth during times of economic crisis, as not many people will travel anymore. Apart from this, the company will see a freight rates slumped to nearly all-time lows, as airline struggled with low demand for their services.As a result, Unlimited Airway and Great Flight, both belonging to the Aviation sector, will experience negative growth. And since Unlimited Airway invested in Great Flight, the losses incurred are amplified.
3.2 Market Risk – Interest Rate RiskUnlimited Airway has also obtained several banks, loans finance its own aviation business expansion. Due to economic crisis, the bank might increase the interest rate of the loans resulting in higher expenses for the Airline, on top of poor sales from the economic downturn.3.
3 Market Risk – Foreign Exchange RiskUnlimited Airway provides intercontinental, intra-continental, domestic, regional and international flight services all year round. Which indicate that it is exposed to foreign exchange risk. For the airline to operate around the world, the company will requires branches to set up all over the world. Transaction Risk ? This can happened when the airline buy or sell products and services denominated in a foreign currency have transaction exposure. Example: If the airline want to do advertisement campaign in an another country, the headquarter will need to support.
Thus, exposing to transaction risk. Translation Risk ? Results whenever assets, liabilities or profits are translated from the operation currency into a reporting currency from sub-branches around the world to headquarter.Example: The sub-branches around the world will needs to send in their financial report and needs to standardize the currency. Economic Risk ? It affects an the airline competitive position as a result of changes in exchange rates. Example: If the airline is having a promotion period and if the currency will to fluctuate in favor of the airline will result in lesser expenses for the airline.
3.4 Market Risk – Commodity Price RiskUnlimited Airway provides services all year round, regardless of the economic condition. Thus, it will be exposed to potential for changes in the price of a commodity that must be purchased such as crude oil.Derivatives Used Forward ContractOne of the derivatives will be forward contract.
Forward contract is a private agreement between the buyer and the seller which gives the buyer/seller the right to purchase/sell an assets at a set price at a future point in time. However, forward contract are not standardized or traded on an exchange. They are just private agreement with terms and conditions which may vary from one to another. United Airway, do not normally seek profit when using forward contract for crude oil but rather seek to stabilize revenue or expenses of their business operations. This will helps the company to reduce the risk of rising oil prices and also the risk of fluctuation of exchange rates if the airline will to use forward contract for currency exchange. United Airway has to provide services all year round, regardless of fluctuation of oil prices. And if the airline anticipated that the oil prices will be rising in near future, the company can uses a forward contract for crude oil. This will help the company to reduce the risk of rising oil prices and puts the company in advantage position as their expenses will be lesser compared to their fellow competitor.
Allowing the airline to sells their air ticket at a cheaper price. Apart from that, the airline could uses forward contract to minimize the risk of fluctuation of exchange rates.