January 23 th 2015 Team FO Hedging strategy and pension fund management of IceAir

Introduction 1- Description of the company 2- Fuel hedging strategies 3- Pension fund management 4- Conclusion

Current situation Company Description Specialized in passenger air transportation, distribution and marketing of vacation packages in Canada Serves 42 seasonal destinations in Europe and 72 seasonal destinations in the Caribbean Fuel prices exposure Industry competitive pressures prevent the company to channel cost increases to customers Head of risk management has just left the company New fuel price hedging strategy is needed going forward Underfunded pension fund Defined benefit Deficit significantly increased in recent years Active management for a portion of the portfolio Developing a hedging strategy and pension liability management strategy is required for company success

Historical Oil Prices Since the financial crisis of 2008, the WTI oil price has increased sharply due to the economic recovery

US Production Growth In our view the increasing global supply as well as weakened global economic factors will lead to a decrease in oil prices Main Catalysts: 1.Increasing U.S oil production 2.Slowing down of emerging markets 3.European recession Demand Supply WTI Oil Price

European GDP Growth Europe has been experiencing negative GDP growth in the past 3 years

Asian GDP Growth Asia and emerging markets have experienced slower growth

Hedging Strategy Based on historical data, the company’s five year yearly fuel consumption for the month of March is 12% and the needed fuel is 663 thousand barrels. 3 Main Criteria's: 1.Strategy that allows the company to benefit from the future expected oil price decrease 2.Protects the company in the event of a an oil price increase 3.Has the lowest volatility in terms of payout Hedging Strategies: 1.Futures 2.Swap 3.Options I.Put II.Call III.Covered call IV.Bear Spread

Futures Description: Gives the buyer of the contract, the right and obligation, to buy the underlying commodity at the price at which he buys the futures contract Futures could provide potential upside in the event of a WTI oil price increase but is also very volatile $6.63M Gain

Swaps Description: An agreement whereby a floating (or market) price is exchanged for a fixed price, over a specified period of time. Swaps could provide potential upside in the event of a WTI oil price increase but is also very volatile $6.63M Gain

Call Provides the buyer of the contract the right, but not the obligation, to purchase a particular amount of a specific commodity on or before a specific date or period of time. Call options could provide potential upside in the event of a WTI oil price increase but doesn’t provide upside in the event of price depreciation $4.46M Loss

Put Provides the buyer of the contract the right, but not the obligation, to sell a particular amount of a specific commodity on or before a specific date or period of time. The Put Bear Spread Hedging provides potential profit in the event of price depcreciation and offers some protection as well Significant Upside $4.46M Loss

An option strategy seeking maximum profit when the price of the underlying security declines. The strategy involves the simultaneous purchase and sale of options; puts or calls can be used $3.32M Gain $3.32M Loss Put Bear Spread The Put Bear Spread Hedging provides potential profit in the event of price depcreciation and offers some protection as well

Hedging Summary MethodProfit against WTI price depreciation Profit against price appreciation Protection against Payout Volatility Swap Futures Put Call Put Bear Spread The Put Bear Spread and the Put option are the two best alternatives Met Investment Criteria Didn’t meet investment criteria Legend:

Long Put vs. Put Bear Spread The Put Bear Spread Hedging strategy would be the best alternative Since reduces the distance of the breakeven price and decreases the capital required to be bearish on a stock $4.46M Loss $3.32M Gain $3.32M Loss Significant Upside

Hedging Implementation Implementation Strategy: 1.Hedge 100% of March fuel needs ($66.3M) 2.Purchase Put Options at a price of 2$, with a strike price of $105 3.Write put option at a price of 7$, with a strike price of $95 4.If the price dips below the $105 exercise price, buy the option for the lower price to realize a gain of $3.32M Payout Schedule

Current Portfolio Snapshot No more than 10% of the portfolio in cash Bullish on US and emerging country equity Neutral concerning Canadian equity Expects higher interest rates in Canada and US BondsCashEquity 63%24%13% % 54.18%0.00% AllocationLY Return

Efficient Frontier of Risky Assets Stock EquityStock Bond Return7.60%4.88% S.Dev17.66%9.47% Correlation CoefficientCovariance

Proposed Asset Allocation year T. Bond and S&P500 historical returns Difference in cash invested in equity to match efficient asset allocation BondsCashEquity 62% 33%5% 4.88%7.60%0.00% Allocation Historical return

Passive Management iShares Barclays 20+ Yr T.Bonds Vanguard Long-term Bond ETF Vanguard Total Bond Market ETF Equity portfolio breakdown 1.All of the exposure is to US bond market 2.Expectations of an increase in interest rates 3.US equity market expected to outperform Canadian Bond Portfolio Key Concerns 1.Underfunded pension fund 2.Long term results Key Considerations

Proposed Bond Portfolio New Bond Portfolio Allocations iShares Barclays 20+Yr T.Bonds – 40% iShares DEX Long Term Bond Index – 40% Vanguard Total International Bond ETF – 20% Rationale US market to outperform Canadian broad market Diversify geographic exposure even further Diversify geographic exposure and focus on long-term results

Active Management Carnival Corp Transat AT iShares S&P/TSX 60 Equity portfolio breakdown 1. 68% of the equity portfolio tied to 2 stocks 2.Combined beta of All of the exposure is to 1 sector Equity Portfolio Key Concerns 1.Underfunded pension fund 2.Long term results Key Considerations Far from ideal for an underfunded defined benefit pension fund

Equity Portfolio Other Assets Consideration Stable business with predictable cash flows to reduce variability of returns Inflation indexed returns Low correlation with the general market

Equity Portfolio Other Assets Consideration Stable business with predictable cash flows to reduce variability of returns Inflation indexed returns Low correlation with the general market Propose real return assets

Equity Portfolio New Equity Portfolio Allocations S&P 500 ETF – 50% Infrastructure Index – 45% Emerging Markets Index – 5% Rationale US market to outperform Canadian broad market Reduce portfolio volatility Capture emerging markets upside Diversify risk and capture upside from global macroeconomic trends

Conclusion Implement hedging strategies Mitigate commodity price volatility Concentrate on core competencies Rebalance pension portfolio Avoid further deficits Maintain long-term safety of pension assets

January 23 th 2015 Team FO Thank You Questions?