Academia - Financial Management and Markets - Derivative Contracts

Academia - Derivative Contracts
Guillermo "Fred" Rivera
Management and Markets
December 08, 2014

Week 6 Signature Assignment - Derivative Contracts Part 6
Most publicly traded companies participate in arbitrage transactions
also known as derivative contracts. Examine the ITEM 7 Management
Discussion and Analysis section of the Republic Airways Holdings, Inc. SEC
10-K and summarize at least two of the derivative contracts. Be sure to
comment if the transactions are internal or external to the company's
business. It is in order to first define what "Derivative Contracts" mean:
The derivative itself is merely a contract between two or more parties. Its
value is determined by fluctuations in the underlying asset. The most
common underlying assets include stocks, bonds, commodities, currencies,
interest rates and market indexes. Most derivatives are characterized by
high leverage (Derivative definition, 2014).
Furthermore, the term derivative is a contract applies to a contract
between two or more parties whose value is based on an agreed-upon
underlying financial asset, index or security. Common underlying
instruments include: bonds, commodities, currencies, interest rates, market
indexes and stocks. Futures contracts, forward contracts, options, swaps
and warrants are common derivatives. A futures contract, for example, is a
derivative because its value is affected by the performance of the
underlying contract. Similarly, a stock option is a derivative because its
value is "derived" from that of the underlying stock. Derivatives are used
for speculating and hedging purposes. Speculators seek to profit from
changing prices in the underlying asset, index or security. For example, a
trader may attempt to profit from an anticipated drop in an index's price
by selling (or going "short") the related futures contract. Derivatives
used as a hedge allow the risks associated with the underlying asset's
price to be transferred between the parties involved in the contract.
Using another example, the writer shares this thought; commodity
derivatives are used by farmers and millers to provide a degree of
"insurance." The farmer enters the contract to lock in an acceptable price
for the commodity; the miller enters the contract to lock in a guaranteed
supply of the commodity. Although both the farmer and the miller have
reduced risk by hedging, both remain exposed to the risks that prices will
change. While the farmer locks in a specified price for the commodity,
prices could rise (due to, for instance, reduced supply because of weather-
related events) and the farmer will end up losing any additional income
that could have been earned. Likewise, prices for the commodity could drop
and the miller will have to pay more for the commodity than he otherwise
would have. Some derivatives are traded on national securities exchanges
and are regulated by the U.S. Securities and Exchange Commission (SEC).
Other derivatives are traded over-the-counter (OTC); these derivatives
represent individually negotiated agreement between parties (Jean Folger,
n.d.).
Republic Airways Holdings, Inc. operates as an airline holding
company. It offers scheduled commercial passenger services through
Chautauqua Airlines, Republic Airlines and Shuttle America subsidiaries.
The company's aircraft and scheduled passenger services are provided
through airline partner brands, including American Eagle, Delta Connection,
United Express and US Airways Express. Republic Airways Holdings business
roots back to 1973 when Joel and Gloria Hall founded its initial business
as Chautauqua Airlines in Jamestown, NY. The company was founded in 1996
and is headquartered in Indianapolis, IN.
Derivative contract number 1.-
We have fixed-fee regional jet code-share agreements with each of our
Partners that require us to maintain specified performance levels. Pursuant
to these fixed-fee agreements, which provide for minimum aircraft
utilization at fixed rates, we are authorized to use our Partners' two-
character flight designation codes to identify our flights and fares in our
Partners' computer reservation systems, to paint our aircraft in the style
of our Partners, to use their service marks and to market ourselves as a
carrier for our Partners. Our fixed-fee agreements have historically
limited our exposure to fluctuations in fuel prices, fare competition and
passenger volumes. Our development of relationships with multiple major
airlines has enabled us to reduce our dependence on any single airline,
allocate our overhead more efficiently among our Partners and reduce the
cost of our services to our Partners.
We intend to maintain a modern, high-quality fleet of regional
aircraft that meets or exceeds stringent industry operating standards and
complies with the terms of our fixed-fee regional aircraft code-share
agreements. Our operations are concentrated in the Northeast and Midwest
and we staff our crew and maintenance bases to leverage our resources
across our network. Continue to provide efficient and effective solutions
to our Partners. We have strong, long-term relationships with each of our
Partners and have historically worked together with them to meet their
operational and network needs. Historically, we have provided safe,
reliable, and cost-efficient solutions for our Partners. We remain focused
on anticipating and continuing to assist our Partners with their business
strategies.
Under our fixed-fee Jet Services Agreements with US Airways, we
operated, as of December 31, 2013, 20 E170 aircraft and 38 E175 aircraft.
As of December 31, 2013, we were providing 337 flights per day as US
Airways Express. In exchange for providing the designated number of
flights and performing our other obligations under the code-share
agreements, we receive compensation from US Airways three times each month.
We receive an additional amount per available seat mile flown and may also
receive incentives or pay penalties based upon our performance, including
fleet launch performance, on-time departure performance and completion
percentage rates.
In addition, certain operating costs are considered pass through costs
whereby US Airways has agreed to reimburse us the actual amount of costs we
incur for these items. Landing fees, passenger catering, passenger
liability insurance and aircraft property tax costs are pass through costs
and are included in our fixed-fee services revenue. US Airways provides
fuel directly for all of our US Airways operations. This derivative
contract allows Republic Airways Holdings Inc., to have use of other
carrier's airlines for a share fee under contract. Whether Republic or
their partners fail to provide the service, either side has to pay the
consequences, this is an internal/external derivative contract.
Derivative contract number 2.-
As of December 31, 2013, we operated 15 E140 and 16 E175 aircraft for
American under a fixed-fee code-share agreement and provided 216 flights
per day as American Eagle. Under the code-share agreement, American
retains all passengers, certain cargo and other revenues associated with
each flight, and is responsible for all revenue-related expenses. We share
revenue with American for certain cargo shipments. Additionally, certain
operating costs are considered pass through costs and American has agreed
to reimburse us the actual amount of costs we incur for these items.
Aircraft lease payments are also considered a pass through cost, but are
limited to a specified amount. Landing fees, hull and liability insurance
and aircraft property tax costs are pass through costs and included in our
fixed-fee services revenue. We do not record fuel expense and the related
revenue for the American operations.


The E140 code-share agreement terminates in August 2014, with aircraft
terms expiring between March 2014 and August 2014. In addition, the code-
share agreements may be terminated under certain conditions. On January
24, 2013, the Company announced that it had reached an agreement with
American to operate 53 Embraer E175 aircraft under the American Eagle brand
with service that began in June 2013. This agreement was subsequently
amended on February 28, 2013 to reduce the number of covered aircraft from
53 to 47. The amended agreement was approved by the Bankruptcy Court on
March 12, 2013 in the American Bankruptcy proceedings. Take advantage of
growth opportunities to operate larger regional jets. Network carrier
consolidation, along with high fuel prices, has limited the economic use of
smaller regional jets. Our Partners have shown an interest in having more,
larger regional jets in their networks.
We believe our existing relationship with our Partners and our strong
relationship with Embraer make us well-positioned to take advantage of any
growth opportunities. Develop culture that attracts and retains qualified
airline professionals working together, we will provide the safest, most
reliable and convenient travel experience for our passengers and a positive
work environment for our associates. We strive to make our company the
employer of choice for regional airline professionals enabling us to
develop mutually beneficial working relationships with our business
partners. This derivative contract is an internal contract between
Republic Airways Holdings Inc. and partners and employees. By allowing
this contract to exist, Republic Airways Holdings Inc. ensures fair
treatment of employees and partners alike.



References:
Derivative definition, 2014. Investopedia. Retrieved from:
www.investopedia.com
/terms/d/derivative.asp
Folger, J. n.d. What is a Derivative? Retrieved from:
http://www.investopedia.com
/ask/answers/12/derivative.asp
Republic Airways Holdings Inc. (RJET) Retrieved from:
http://biz.yahoo.com/e/140311/rjet10-
k.html
Ross, Stephen A., Westerfield, Randolph Wl, Jaffe, Jeffrey, (2013).
Financial Management
(customized) New York, NY: McGraw Hill.