w HARVARD |BUSINESS|SCHOOL 9-204-024 Foreign Exchange Hedging Strategies at General Motors 1n September of 2001, Eric Feldstein, Treasurer and Vice President, Finance for General Motors, Corp. paid litle atention to his unobstructed view of Central Park from his office far above the Mannettan traffic He had three risk management decisions to make: what to do about () GM's lion dollar exposure to the Canadian dollar, (i) GM's exposure to the Argentinean peso in ight of the expected devaluation in the months aheed, and (ii) the continuing strategic concem sbont factuctions in the Japanese yen, which figured 60 heavily into the cost structures of some of GM's competitors. Feldstein and his tresusy team were responsible forall of GM's monetary transactions end for managing the myriad risks associated with the timing of those transactions. ‘They handled tvesything from ivesting excess cash from vehicle sales receipts to hedging currency risks when fovegn subsidiary ike Opel Ausbia announced it would remit a dividend to the worldwide parert Ginuany, The GM Treasury progrem invested hesvily in its people, rotating them Hous ‘SGhekional positions and offices around the world, developing thelr skills and experience. The wit anfinued fo produce individuals who went on to senior finance positions with GM subsidiaries or SHuewhere within the GM organization of left for senioz roles at other major U.S. companies, ‘As GM expanded around the worl, the magnitude of its exposures to foreign currencies grew, Becmuse exchange rate swings created gains and losses that flowed through GM's reported sacome ‘etement, it wes essential from a planning and management perspective to understand GM's foreign Shchange flows and to manage the amount of earnings and cash flow volatility they imposed of GM faldetels constantly followed news on volatile political situations around the world and kept abreast lof macroeconomic trends that might affect GM's finances, GM senior executives had implemented a number of formal policies with respect to foreign exchenge isk management and hedging procedures. ‘These policies guided the vast majoisy of fensury operations, but on occasion situations azose that required special attention and povdlly 4 treasury Pom the stated policy. Feldstein was reviewing proposals for the Canadian dollar (CAD), ‘Kagentnean peso (ARS), and Japanese yen (PY). He had the authority to sign off on each deviation ‘rtmmer eA Doss andRench Assoc Mark F.VSen prepare cv, cat ot devloped sally 4 hs no, roar Mas Des Re hae bss cope aor ft the ecu aprons of General Mot erp Cera rt came, Cr Saviors pany at or Huson esi ar ntietive mangement, pig 208 Pre Flas of Hare Clee, To oe pe or gee paminon a era Copyright 20 rs ing any MA Bi, got p/m pares ‘No par of ts obo O9 re Herr Be ee ry, ed nn renee of Sapo ny for by any manele, mea erat gncndng or oberisewiboxt te peas of Harvard Bsn S200oem Foreign Exchange Hedging Strategies at General Motors Overview of General Motors and its Treasury Operations General Motors* General Motors was the world’s largest automaker, with unit sales of 85 million vehicles in 2001--15.1% worldwide market share—and had been the world’s sales leader since 1931. Founded in 1908, GM had manufacturing operations in more than 30 countries, and its vehicles were sold in approximately 200 countries. In 2000, it genereted earnings of $44 billion on sales of $184.6 billion (Gee Exhibit 1 for GM's consolidated income statement), The labo: costs for its 965,000 employees in that year amounted to $19.8 billion, only $8.5 billion of which was for US-based personnel. In addition to vehicles, other major product lines included (@) financial services for automotive, mortgage, and business financing, and insurance services through General Motors Acceptance Corporation (GMAC), (i) satellite television and commercial satellite services through Hughes Electronics, and (il) locomotives and heavy duty transmissions through GM Locomotive Group and ‘Allison Transmission Division. GM traded on the New York Stock Exchange and was a component of the Dow Jones Industrial Average. While North America still represented the majority of sales to end customers and the largest concentration of net property, plant, and equipment (see Exhibit 2 and Exhibit 9), the importance of GM's international operations was growing as a percent of the overall business. With globalized production, these figures understated the degree to which intermediate goods in GM's supply chain Proved around the world. Its matket share in Latin America was 20% and in Europe had reached {0% (20% if Fiat's figures were included”). Increasing market share in Asia, which stood at 4%, was a ‘major strategic objective for GM. General Motors Treasurer's Office (GM's Treasurer's Office performed a full range of corporate treasury functions from its head office in New York and through additional locations in Brussels, Singapore and Detroit. The organizational structure shown in Exhibit 4 demonstrates the nature and extent of those activities, (One of the key functions of the Treasurer's Office was financia) risk management. This included ‘management of not only market risk (foreign exchange, interest rate end commodities exposures) but also counterparty, corporate and operational risk, Exhibit 5 outlines the components of this function ‘and demonstrates the high degree of centralization in approach, [All of GM’s financial risk management activities were subject to oversight by the Risk Management Committe, waich was composed of six of GM's most senior executives including Feldstein? The commiliee met quarte:ly to” review the-performance-of GM's_financlal_risk fnanagement stategies and 10 set treasury policy for GM and its subsidiaries, Treasury policy tnaluced evaluating the parameters and benchmarks for menaging market risks, determining citeia for assessing counterpesty credit risk, determining thresholds for property end liability insurance + stasis down fom General Motors, 2003 Anal Rapor (Detroit: General Motors, 2002) nd General Motors, December $1, 2001 10% (Detroit: General Motors, 2002). 2 General Motors ovmed 20% of Flat and Fat held an option to put the remaining 0% to GM. 4 other members of the Risk Management Commitee were the Chief Financial Officer the General Autor, the Chief ‘pcos Oifcer the Cie Beonomst ad esnior exezutive rom Genera Motors Acceptance Corportion (GMAC) GM's ‘nell sarvies subsidiary.orsign Exchange Hedging Strategies at General Motors 2otaa coverage, as well as reviewing intemal control aspects of operating policies and procedures. GM's formal, company-wide policies contained not only broad principles, but also detailed execution procedures such as, in the case of foreign exchange risk management, the types of instruments to be ‘ised and the appropriate time hotizons.‘ At its meetings the committe also discussed. any special topics that needed to be addressed. Such special topics often included precisely the deviations from ‘usual policy Feldstein was currently considering, ‘Various groups within the Treasurer’s Office were involved in the implementation of financial risk management policy. For foreign exchange, all of GM's hedging activities were concentrated in two centers: + ‘The Domestic Finance group in New York handled FX hedging for GM entities located in. North America, Latin America, Africa and the Middle East © The European Regional Treasury Center (ERTC) was GM's largest foreign exchange operation, covering European and Asia Pacific FX exposures FX hedging activities were segregated in this way on the principle that there should be some geographic correspondence between where a business unit was actually managed and where ‘easury for that business was controlled. At the same time, though, it was considered desirable to reap the benefits of pooling exposures across groups. In a sense, the goal was to match treasury management to the footprint of the business, Having local market knowledge and a trading center in both the European and US. time zones was also very helpful, because GM was active in each of the ‘major foreign exchange markets. In managing the FX exposures, both the Domestic Finance group and the ERTC worked closely with other groups within Treasury that had the primary responsibility of providing strategic support to GM entities within that region. These groups were also the global coordinators for intercompany loans, moved cash around the world to finance overseas mergers and acquisitions activities, and managed dividend repatriations. Review of Corporate Hedging Policy General Motors's overall foreign exchange risk management policy was established to meet three primary objectives: (1) reduce cash flow and earings volatility, (2) minimize the management time Phd costs Gedicated to global FX management, and (3) align FX management in a manner consistent ‘rith how GM opezates its automotive business, The first constituted a conscious decision to hedge Tash flows ((ransection exposures®) only and ignore balance sheet exposures (translation exposures ‘The second objective was a consequence of an internal study that determined that investment of resources in active FX management had not resulted in significantly outperforming passive “yt poe spel, for example, which aks were fo behedged using forward contacts riher than options contracts 5 transncion expnuies ae the gains and losses that ase when transactions ae sted in some currency other than 2 aaa ae. ing carne. Tese exposes tem roms buying end sling ates swell as fuancing deisions much a3 SORPEUE "Sor hater deal see W. Ca Kertr and Richard Pele “Note on Transaction and Traraation Exposure,” HBS Case No. 9252-017 (Boston: Harvard Busines School Publishing, 1987 rv. 1972), ‘qyensation exporures ae the guns and losses hat vise when the assets nd abilites of a maltinatona’s foreign subskiary tor tnutatea bk info the mtinaiona’s reporting currency fr the purposes of preparing consolidated financial satemen's- Soy fonts deal see W. Corl Xester and Richard P, Melnick, "Note on Teansnction and Translation Exposure” HBS Case No, 5:266.217 (Boston Hlarvaré Basness School Publishing, 1967, rev. 1952),