Foreign Exchange Hedging Strategies at General Motors

Case Study Solution

Agenda 1. What kinds of risks do FX pose for multinationals? 2. How should a MNC design a risk management policy for FX? 3. How would you evaluate GM¶s hedging policy? 4. Why is the CAD exposure so troubling? 5. How do you trade off options and forwards? 6. How is GM exposed to the yen? 2

Why do companies hedge? To reduce transaction costs. why should a firm do so? A firm can likely hedge more efficiently than an individual investor To provide for future investment needs To manage earnings To speculate To make evaluating a company¶s operations easier To make the comparison of the foreign subsidiary operations easier 3 . Since individual investors can hedge on their own.

Translational exposures ‡ ‡ Not economic one Affect balance sheet 3.What risks do multinationals face from FX? 1. Transactional exposures ‡ ‡ Arise from real transactions such as debt and A/R Affect income statement 2. Operational exposures ‡ ‡ Real and economic Indirectly arise from competitive interactions 4 .

³passive´ Forwards (0-6) and options (6-12) Regionally When to deviate? Try to stay ³passive´.What questions must an FX hedging policy of GM address? What to hedge? Transactional exposures only and only those with an ³implied risk´ over $10 million (over $5 million for especially volatile currencies) How much to hedge? How to hedge? Where to hedge? 50% ration. hedging decisions that do not follow the policy require approval What is the difference between active and passive hedging? Shapiro: Unknown cash flow should use option 5 .

Argentina peso How to deal with the widely-anticipated evaluation of the peso 3.FX exposures to GM 1. CAD Transactional and translational exposures 2. Yen Operating exposure 6 .

7 . GM hedges 50% of the exposure.GM¶s Policy on how much to hedge GM forecasts operating exposures for all its regions on a monthly basis. The ³riskiness´ of these exposures = net(regional) exposure * annual volatility of the currency pair (%) If the result > $10 million.

S.How much to hedge? GM¶s North American region had a forecast euro exposure of $400 million. GM hedged $200 million of its euro exposure 8 . dollar ±euro exchange was 12% The implied riskiness of the exposure was $48 million. and the annual volatility of the U.

9 . We hedge the ³underlying´ risk.Should GM hedge the amount ³at risk.´ of $48 million or $200 million (50% of the total euro exposure)? 48 million ³implied risk´ is calculated simply to determine if GM should hedge.

10 .How much to hedge? The value of our car is $30.000.500. not $1.500 How much will you buy the insurance? We will buy the insurance for the full value of the car. or $30.000 and there is a 5% probability of accident The expected outcome of accident is losing $1.

so the exposures of different subsidiaries would often cancel out Save costs Con: GM¶s subsidiaries have their own objectives. 11 .Should GM hedge on a worldwide or regional basis? Pro: GM operates in so many countries.

Why do GM requires approval for deviations from its hedging policy? GM used to actively manage its myriad currency risks. GM did not consider that active management provided significantly better results. 12 . ³Active´ FX management demands considerable manpower and management attention.

Does GM¶s policy on how much to hedge make sense? Why not 40% or 100%? Hedge 50% of FX exposures .³safe´ The mid-point a prudent choice Easy to explain to shareholders Maybe a legal reason Expensive to hedge 100% 13 .

50% of this exposure should be hedged.Canadian Dollar Exposure GM is short about CAD 1. A transactional exposure.7 billion It has to pay Canadian suppliers for materials and services. According to GM¶s hedging policy. 14 .

In effect. 15 .Why did managers request to hedge 75% of this exposure? The concern is that GM Canada¶s balance sheet includes significant pension obligations. A total balance sheet exposure is CAD 2. the translational exposure would be hedged by increasing the hedge on the transactional exposure.1 billion GM¶s hedging policy excludes hedging such translational exposure.

1%) 1.0% 3.4) 25.1%) 1.4) (17.sensitivity 50.5780 (3.6) 40.6269 1.5780 (3.0 (26.143) (2.8 (16.6 (17.How big a difference is this to GM? HEDGE RATIO SCENARIO .1 (43.5780 3.5291 1.1% 1.682) (1.143) (2.6269 16 .1% Stronger 3.682) (1.8 10.5780 3.261 (420) (1.1% Weaker (1.8 (24.5291 1.9) (11.682) (841) 841 (841) (1.2) 40.9 1.1% Stronger 3.261 (420) (2.4) 17.1% Weaker 75.261) 1.8 16.0) 16.1% 1.0) 24.143) (2.261) 1.143) (43.0% 3.CAD is: Commercial exposure 12-month rolling net receivables forecast (CAD) Notional hedge amount at hedge ratio (CAD) Net cash (CAD) FX hedge put in place (CAD) Net FX exposure (CAD) GM Worldwide US GAPP FX exposure GM Worldwide US GAPP FX exposure (CAD) Earnings impact on GM Worldwide GM Worldwide FX gain/(loss) FX gain/(loss) on hedges GM Worldwide pre-tax income impact GM Worldwide after-tax (35%) income impact Scenario CAD/USD FX rate Range CAD/USD FX rate .682) (841) 841 (841) (1.

Why is the CAD exposure so problematic? ‡Transactional ± Short CAD 1.1bn ‡What are they doing? ± Hedging a translational exposure through increased ³transactional´ hedges« ‡How should GM use forward and options to hedge? 17 .7bn ‡Translational ± Short CAD 2.

How can forwards and options be compared for hedging the CAD? 2.000 500.000.000) (1.500.000.000.000 - (500.000) 14000 14500 15000 15500 16000 16500 17000 17500 18000 18 .000.000 Exp + Fwd 1.000 Exp + Opt Exposure 1.000) (1.000) (2.500.

What about the ARS exposure? What can you do about that now? What are the forward rates telling you? What does this mean for how expensive hedging is by this time? 19 .

How and why is the yen a competitive exposure? Tracing the chain through all the way from a yen devaluation to GM PV consequences« 20 .

But how does the yen exposure fit in with other yen exposures? These exposures must be combined relative to other exposures« 21 .

Increase investments in Japanese companies 22 . Borrow yen and use yen to finance its lower price strategy ‡ Might be easier than buying a Japanese plant 4. Change sourcing ‡ 3.What else can GM do about the yen exposure? 1. Lower its own US prices domestically ‡ To combat some loss in market share Get same benefits as Japanese automakers ± buy plants in Japan 2.

987 *S&P500 returns) ‡ GM moves in line with market Monthly returns of GM = a + 0. 23 . Harley-Davidson Steel How could we analyze GM¶s competitive exposure to the yen more rigorously? Monthly returns of GM = a + (0. GM stock return increase 4%.What other companies would you expect competitive exposures to be big in? Boeing & Airbus.4 (returns of $/yen) ‡ When we see 10% devaluation in USD.

2001. 453-475 24 .´ Journal of Financial Economics 59.Source: Rohan Williamson. ³Exchange rate exposure and competition: evidence from the automative industry.

2001. 453-475 25 .´ Journal of Financial Economics 59.Source: Rohan Williamson. ³Exchange rate exposure and competition: evidence from the automative industry.

´ Journal of Financial Economics 59. 2001. 453-475 26 .Source: Rohan Williamson. ³Exchange rate exposure and competition: evidence from the automative industry.

Why has yen become more important? Closer integration of product market 27 .