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Principles of Finance

Why It Matters

Principles of FinanceWhy It Matters
Lettered dice spell out the word risk on top of dollar bills.
Figure 20.1 Financial managers must consider prudent ways to manage economic volatility and the risk it poses to a company. (credit: modification of “Risk text on Dollar banknotes” by Marco Verch/flickr CC BY 2.0)

Chapter Outline

20.1 The Importance of Risk Management
20.2 Commodity Price Risk
20.3 Exchange Rates and Risk
20.4 Interest Rate Risk

Each year, American Airlines consumes approximately four billion gallons of jet fuel.1 In the spring of 2018, jet fuel prices rose from an average of $2.07 per gallon to a price of $2.19 per gallon.2 A $0.12-per-gallon increase in the price of jet fuel may not seem significant, but on an annualized basis, a price increase of this magnitude would increase the company’s jet fuel bill by approximately $500 million.

That added cost cuts into the profits of the company, leaving less money available to provide a return to the company’s investors. Rising costs could even cause the business to become unprofitable and close, causing many employees to lose their jobs. The financial managers of American Airlines are not able to control the price of jet fuel. However, they must be aware of the risk that price volatility poses to the company and consider prudent ways to manage this risk.

Footnotes

  • 1American Airlines. American Airlines 2019 Environmental Data. Accessed July 8, 2021. https://www.americanairlines.in/content/images/customer-service/about-us/corporate-governance/aag-2019-environmental-data.pdf
  • 2S&P Global. “Platts Jet Fuel.” S&P Global Platts. Accessed July 8, 2021. https://www.spglobal.com/platts/en/oil/refined-products/jetfuel#
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