Financial risk arises through countless transactions of a financial nature, including sales and purchases, investments and loans, and various other business activities. According to Essentials of Risk Management, financial risks mainly arising from an organization's exposure to changes in market prices; from the actions of and transactions with other organizations; from internal actions or failures of the organization.
"There are two components to assessing financial risk. The first component is an understanding of potential loss as a result of a particular rate or price change. The second component is an estimate of the probability of such an event occurring." (Horcher, 2005) As a result, this essay is going to use this method and analyze the financial risks of easyjet in three aspects: market risks, credit risk and liquidity risk.
Market risks
Market risk is the risk of losses in positions arising from movements in market prices.[1] For easyjet, the company is exposed to exchange rates risks, interest rates risks and fuel risks.
For foreign exchange rate, because of the fluctuations in both the US dollar and euro rates, operating, financing and investing activities of easyjet may be adversely affected. According to the annual report, it is estimated that at current exchange rates and fuel remain within its recent $1,000 m/t to $1,100 m/t trading range. Although the company has policies of matching and forward foreign exchange contracts, the weakness of euro is still continuing, easyjet cannot eradicate the negative impact from instable changing rate.
Changes in interest rate can affect both floating rate borrowings and cash investments. In 2012, the interest rate analysis assumes a 1% change in interest rates over the reporting year applied to end of year financial instruments. Fortunately, of the 55 operating leases in place at 30 September 2012, 75% were based on fixed interest rates and 25% were based on floating interest rates (2011: 69% fixed, 31% floating). All debt is asset related, reflecting the capital intensive nature of the airline industry and the attractiveness of aircraft as security to lenders. These factors are also reflected in the medium term profile of easyjet's borrowings and operating leases.
As an airline company, every year easyjet cost a large proportion of total expense on importing fuel. As a result, the company is going to sustain fluctuation of fuel price. What's more, due to over exploitation in last decades, there is oil shortage worldwide. In additional, continuously wars in oil producing areas also have negative impact on importing fuel of easyjet. Although the annual report of easyjet shows that hedges of fuel price in 2012 increased from 21 million to 39 million, the company still could be suffering from the uncertainties of fuel hedging.
Easyjet aims to limit market risks with selected derivative hedging instruments. EasyJet policy is not to trade in derivatives but to use the instruments to hedge anticipated exposure. As such, easyJet is not exposed to market risks by using derivatives as any gains and losses arising are offset by the outcome of the underlying exposure being hedged. The policy is regularly reviewed to ensure best practice, however there have been no significant changes during the current year.
Credit risks
Credit risk is the risk that a counterparty will not settle an obligation for full value, either when due or at any time thereafter. [1] Traditional credit risk involves the default on a payment and the performance of counterparties in contracts or agreements.
EasyJet is exposed to credit risk arising from cash and money market deposits, derivative financial instruments and trade and other receivables.
Money market deposit this year is 238 million which is 7 million less than it was in 2011, and its net decrease is 55 million. The decrease of money market deposit shows that easyjet tends to have less money on saving account. Profit on derivative financial instruments in 2012 has decreased by 4 million, while the fair value of it increased by 16 million. It is reflected that although the total value of derivative financial instruments increased, the company still sustained profit loss.
Credit rating is not only useful for counterparties but also determines the maximum period of investment when placing funds on deposit. Credit risk is limited to the carrying amount in the statement of financial position at each year end.
Counterparties for cash investments, currency forward contracts and jet fuel forward contracts are required to have a credit rating of A or better at contract inception and credit limits differentiate between A, AA and AAA rated counterparties. Exposures to those counterparties are regularly reviewed and adjusted as considered appropriate when the market view of counterparty's credit quality changes. Accordingly in normal market conditions, the probability of material loss due to non-performance by counterparties is considered to be low.
Liquidity risks
Liquidity risk represents the risk that a counterparty (or participant in a settlement system) will not settle an obligation for full value when due. Liquidity risk does not imply that a counterparty or participant is insolvent since it may be able to settle the required debit obligations at some unspecified time thereafter.[1] For easyjet, its liquidity risk analysis is focused on sufficient cash resources and the availability of funding as required.
The bar chart below shows the comparison of the liquidity ratio between easyJet and ryanair from 2009 to 2012. The liquidity ratios of easyJet these years remain stable around 1.4% with slightly and steady growth. For Ryanair, the ratio fluctuated between 1.84% and 2.13%. Overall, easyJet remains a lower liquidity rate than its major competitor ryanair, which means easyJet still need to improve its ability to pay off liabilities in short-term.
EasyJet holds financial assets either for which there is a liquid market or which is expected to generate cash inflows that are available to meet liquidity needs.
EasyJet continues to hold significant cash and liquid funds to mitigate the impact of potential business disruption events with Board approved policy stating a target level of liquidity of £4 million per aircraft in the fleet. Total cash (excluding restricted cash) and money market deposits at 30 September 2012 was £883 million (2011: £1,400 million). Surplus funds , usually money market funds or bank deposits ,are invested in high quality short-term liquid instruments.
