Prabhu Ramamoorthy – GM

GM Foreign Exchange Hedge

Date: Presented to: Completed by: November, 2008 Jim Seward Raising Capital and
Financing the Firm Prabhu Ramamoorthy

Recommendations Increase hedge to 75% for hedging the Canadian exposure. The
combined hedge percentage is to account for both operational as well as balance
sheet hedge due to monetary assets on the balance sheet. Hedge the Argentina
position. Hard currency assets must be increased. Hedging can be done using the
forward rates of another reliable hard currency. Other natural ways to hedge would
be through commodities exports/imports done by Argentina.

Alternatives Considered and Ruled Out Not hedge the monetary liabilities in the
balance sheet of the Canadian subsidiary – Monetary liabilities are without respect
to future prices and this may create an exchange risk. So this has to be edged. Not
hedging this would be risky

Analysis Hedging is necessary for a company such as GM. Appendix A provides

arguments along this line. GM has to revise its policies. It should analyze each
transaction on a case by case basis. For transactions that can be subject to high
volatility, it is prudent to hedge a greater percentage of the nominal amount of
the transaction. The current hedging policy does account for this volatility in
calculations of positions to be hedged. A hedging mechanism for such high volatile
currencies ensures that the company does not lose money. The policy must be changed
to assess net balance sheet impact (consider monetary liabilities and balance sheet
effect also). This is because not only operational cash flow items but balance
sheet items such as monetary liability are also subject to exchange risk. If you
consider GM’s Canadian, the operational cash flows are 1,682 (Exhibit 9). Exhibit
10 also reveals an insight on the balance sheet effects and the monetary
liabilities which are subject to exchange rate risk.
Prabhu Ramamoorthy – GM Exhibit 11 shows the ARS Monetary liabilities which are
subject to exchange rate risk. Both ARS monetary assets and liabilities have to be
hedged to prevent erosion of value. One way would be to convert to other hard
currencies in the near future. Also it is reasonable to go for option positions
which are not very long term. Hence 3 or 6 month instruments would be a good way to
reconsider the hedge going forward. You could periodically balance them to remain
neutral, unwind excesses or buy more protection.

Conclusions GM’s policy must be revised. GM’s policy must be revised to consider
balance sheet effects of exchange rate risk also. Similar to operational hedging, a
policy must be developed to support this risk also. Appendix B discusses the
reasons for this policy change. Cumulatively when both the effects are considered
operational and balance sheet, this signifies an increase in hedging. GM can also
hedge more by way of options. Since options have a 50% delta (in the way in which
GM chooses it trades), you may allocate a bigger percentage to options. Hedging by
the way of options results only in premiums whereas hedging by way of forwards may
call for a bigger notional amount in the transaction. Option volatilities may also
be higher and it would be easier to balance a hedge based on options by selling and
buying them. Since the purpose of a hedge is to counteract this volatility,
increasing the option may be a policy change that GM can adopt. In this you could
prevent rollover charges due to futures. Again this depends on a case by case basis
and because of black scholes; you may have to pay a higher for an option even when
it is out of the money. GM must also have a policy in place to prioritize its risk
based on political, economic and technology risk. Having such a policy will ensure
that GM can predict volatility/uncertainty and put its hedge in place.
Prabhu Ramamoorthy – GM Appendix A Should Multinational firms hedge foreign
exchange rate risk? Multinational firms should hedge foreign exchange. This should
be done to prevent 1) Cash flow effect of the foreign firm (if it is denominated in
US dollars) 2) Decline in value of the equity holder due to adverse movements in
exchange rates. In both the cases, stock holder’s equity is impacted. Risk
Management to manage earnings is very crucial and unexpected losses due to not
managing the risk may result in other expenses or failure to meet earnings
estimates. Exhibit 2 and Exhibit 3 reinforce the importance of hedging in GM’s
case.

If not, what are the consequences? Failure to hedge may result in cash flow being
very volatile. Significant fluctuations in foreign exchange distort the cash flow.
The company’s cash flow from operations may be stable but exchange losses/gains may
lend an air of unpredictability to the net income statement and the shareholder’s
equity. In many circumstances of political risk, exchange losses may lead to
extraordinary losses also. If so how should they decide which exposures to hedge?
The positions that should be immediately hedged are the ones which have a lot of
uncertainty tied to them. Example of this would be PESTLE Political, Economic,
Technology, Social Risk.

Companies can use derivatives and financial instruments to hedge the risk One way
would be is to hedge using the commodities market, futures and options. An airline
company may hedge fuel risk by hedging in the commodity. A multinational company
with lots of export/import may follow the same strategy. Another strategy would be
is to use futures, swaps, options and credit default swaps. If currency
appreciates, the seller of the option makes loss. Exchange rates denominated in
foreign currency/USD go up and the amount needed to purchase the forward goes up.
If currency depreciates, the seller of the option makes a profit. Exchange rates
denominated in foreign currency/USD go up and the amount needed to purchase the
forward goes down.
Prabhu Ramamoorthy – GM Appendix B Should GM deviate from its policy in hedging its
CAD exposure? Why or Why not? Yes, GM should deviate from its policy to account for
the balance sheet effect. Hedging must consider this in addition to operational
transactions. If GMS does deviate from its formal policy for its Cad exposure, how
should GM think about whether to use forwards or options for the deviation from the
policy? GM may increase options in its hedge. This strategy allows GM to sell buy
call/options to counter the effects of the hedge. Rebalance, reassess remain delta
neutral. Why is GM worried about the ARS exposure? What operational decisions could
it have made or now make to manage this exposure? GM is worried about its ARS
exposure because of default and devaluation concerns. Moreover forwards are
predicting a high spike.Forwards are already considering this devaluation effect by
prediction that you could get more Pesos per dollar. I would minimize ARS
denominated assets and increase US hard assets. Hedge using labor. Can ARS
liability be hedged through way of commodities and other hedges. If yes ,explore
this aspect.