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Foreign Exchange Hedging Strategies at General Motors

As GM expanded worldwide, the magnitude of its exposures to foreign exchange grew. Exchange rate swings
directly flows into GM’s income statement which associates GM to transactional exposure in forex.
Treasury team was responsible for all of GM’s monetary transactions and all the risk associated with it. Eric
Feldstein, Treasurer and Vice-President, Finance at General Motors had to take significant risk management
decisions regarding their foreign exchange exposure in Canadian dollar and Argentinean peso.
GM had a set of policies with respect to foreign exchange risk management and hedging procedures. But
occasional situations required special attention and a possible deviation from the stated policy. Feldstein, who
had the authority to sign off on policy deviations, was reviewing such proposals for the Canadian dollar and
Argentinean peso.

Canadian Dollar Issue

+ US dollar-denominated flows were so large that the USD was effectively the primary
operating currency of the company despite GM Canada’s very large Canadian dollar assets
and liabilities.
+ Since GM Canada’s functional currency was USD, its exposure to Canadian dollar was
recognized as a foreign currency exposure.
+ Projected Cash flow exposure of GM Canada: -1682 C$
+ Net Monetary Asset/Liability exposure of GM Canada: -2143 C$
+ GM’s policy didn’t allow hedging on Net Monetary Asset/Liability exposure. As such, Feldstein
need to take a decision on how to reduce this exposure.

Review of Corporate hedging strategy

Corporate hedging strategy was establishes to meet three primary objectives:
 Reduce cash flow and earnings volatility
 Minimize the management time and costs dedicated to global FX management
 Align FX management in a manner consistent with how HM operates its automotive business.

Passive Policy: Hedge 50% of commercial Exposures

The policy adopted was generally to hedge 505 of all significant foreign exchange commercial exposures on a
regional level. The policy differentiated between commercial exposures and financial exposures in the
following way:
Commercial exposure-> cash flows associated with the ongoing business such as receivables and dividends
Financial exposure-> debt payments and dividends are considered as financial exposure.
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Calculation of commercial exposure (operating)
Each regional center collected monthly forecasts of accounts receivables and account payable, usually for the
twelve coming months. This information was compiled into a matrix presenting the total exposure by currency
pair for each regional unit. A determination of riskiness was then made on a regional basis. Deciding which FX
exposures were significant enough to warrant hedging.
Implied risk=regional notional exposure X annual volatility of relevant currency pair.
Net exposure within a region was then hedged to a bench mark ratio of 50%.

Commercial exposure (capital expenditure)

GM adopted a different approach to hedge capital expenditures because they did not exhibit the same month-
to-month volatility or changing forecasts. There were two tests for capital expenditure to be hedged:
 The amount should be in excess of $1 million
 The implied risk should be equivalent to at least 10% of unit’s net worth
If investments that met either of the above tests was hedged with forward contracts using a 100% hedge ratio
to the anticipated payment date.

Financial exposure
They were hedged with 100% hedge ratio. Dividends were hedge able only after they were declared, they
were hedged using hedge ratio of 50%.

Translation exposure (balance sheet)

They were not included in GM’s hedging policy.

Reporting
Hedging activities were closely tracked and regularly reviewed within the treasury group. The information was
made available to senior management and to the risk management committee to assist in the policy review
and creation.
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Solution-1:
HEDGE RATIO 50.0%
SCENARIO - CAD is: 3.1% Stronger 3.1% Weaker

Commercial exposure
12-month rolling net receivables forecast (CAD) (1,682) (1,682)

Notional hedge amount at hedge ratio (CAD) (841) (841)

Net cash (CAD) - -
FX hedge put in place (CAD) 841 841

Net FX exposure (CAD) (841) (841)

GM Worldwide US GAPP FX exposure

GM Worldwide US GAPP FX exposure (CAD) (2,143) (2,143)

Earnings impact on GM Worldwide

GM Worldwide FX gain/(loss) (43.4) 40.8
FX gain/(loss) on hedges 17.0 (16.0)
GM Worldwide pre-tax income impact (26.4) 24.8
GM Worldwide after-tax (35%) income impact (17.2) 16.1

Scenario
CAD/USD FX rate 1.5780 1.5780
Range (3.1%) 3.1%
CAD/USD FX rate - sensitivity 1.5291 1.6269

HEDGE RATIO 75%

SCENARIO - CAD is: 3.1% Stronger 3.1% Weaker

Commercial exposure
12-month rolling net receivables forecast (CAD) -1682 -1682

Notional hedge amount at hedge ratio (CAD) -1261 -1261

Net cash (CAD) 0 0
FX hedge put in place (CAD) 1261 1261

Net FX exposure (CAD) -420 -420

GM Worldwide US GAPP FX exposure

GM Worldwide US GAPP FX exposure (CAD) -2143 -2143

Earnings impact on GM Worldwide

GM Worldwide FX gain/(loss) -43.4 40.8
FX gain/(loss) on hedges 25.6 -24.0
GM Worldwide pre-tax income impact -17.9 16.8
GM Worldwide after-tax (35%) income impact -11.6 10.9

Scenario
CAD/USD FX rate 1.578 1.578
Range -0.031 0.031
CAD/USD FX rate - sensitivity 1.529082 1.626918
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Argentinean Peso Issue
+ To rampant inflation, the local government exercised control over foreign currency exchange
and maintained a peg to the US dollar at ARS 1: USD 1.
+ With Debt to Equity ratio of 45% and $16.5 billion coming due soon, “Zero Deficit” law passed
by the government has put Argentina at serious risk of defaulting.
+ Treasury analysts forecast devaluation of ARS against USD from 1:1 to 2:1.
+ Devaluation has two impacts:
- Local currency equivalent of USD borrowing will grow.
- Translational loss on GM Argentina’s ARS denominated net assets.
+ USD liabilities of GM Argentina: $325.7 million.
+ ARS denominated Net Assets: ARS 190 million.
+ Feldstein needs to take decision on how to minimize forex risk associated with GM Argentina.

ARS Monetary Assets (Figures in Million

dollars) ARS Monetary Liability

Scrap incentive owned by Govt. 45.8 Payables to local suppliers 24.1

Provisions to local
Interest subsidy owned by Govt. 3.2 suppliers 11.3
VAT credit and other tax 130.6 ARS loan 13.7
Receivable 2.7 Other Provisions 9.8
Other 7.8 Tax Payable 2
Total 190.1 Total 60.9

Net ARS Exposed Assets 129.2

USD Monetary Assets ( Figures in

Million dollars) USD Monetary Liabilities

Cash 2.5 Accounts Payable 224.5

receivables 20.5 Loans 101.3
Total 23 Total 325.8

Net USD Exposed Liabilities 302.8

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Solution-2:

After 1 month:

Net USD Exposed Liabilities ARS 302.80 $ 302.80

Net ARS Exposed Assets ARS 129.20 $ 129.20

After 1 Month

Forward Rate Peso 1.05/USD

Spot Rate Peso 2/USD

No Hedge Rate (1:1) Rate (2:1) Net Change

Net USD Exposed Liabilities $ 302.80 $ 151.40 $ (151.40)
Net ARS Exposed Assets $ 129.20 $ 64.60 $ (64.60)
Cost of Hedging 0
Total Gain/loss $ (216.00)

Hedged (50%)

Hedged USD Liability $ 151.40 $ 144.19 $ (7.21)

Hedged ARS Assets $ 64.60 $ 61.52 $ (3.08)
Unhedged USD Liability $ 151.40 $ 75.70 $ (75.70)
Unhedged ARS Assets $ 64.60 $ 32.30 $ (32.30)
Cost of hedging $ 4.61
Total Gain/loss $ (122.89)

Hedged (75%)

Hedged USD Liability $ 227.10 $ 216.29 $ (10.81)

Hedged ARS Assets $ 96.90 $ 92.29 $ (4.61)
Unhedged USD Liability $ 75.70 $ 37.85 $ (37.85)
Unhedged ARS Assets $ 32.30 $ 16.15 $ (16.15)
Cost of hedging $ 6.91
Total Gain/loss $ (76.34)
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After 6 months:

After 6 Months

Forward Rate Peso 1.35/USD

Spot Rate Peso 2/USD

No Hedge Rate (1:1) Rate (2:1) Net Change

Net USD Exposed Liabilities $ 302.80 $ 151.40 $ (151.40)
Net ARS Exposed Assets $ 129.20 $ 64.60 $ (64.60)
Cost of Hedging 0
Total Gain/loss $ (216.00)

Hedged (50%)

Hedged USD Liability $ 151.40 $ 112.15 $ (39.25)

Hedged ARS Assets $ 64.60 $ 47.85 $ (16.75)
Unhedged USD Liability $ 151.40 $ 75.70 $ (75.70)
Unhedged ARS Assets $ 64.60 $ 32.30 $ (32.30)
Cost of hedging $ 20.66
Total Gain/loss $ (184.66)

Hedged (75%)

Hedged USD Liability $ 227.10 $ 168.22 $ (58.88)

Hedged ARS Assets $ 96.90 $ 71.78 $ (25.12)
Unhedged USD Liability $ 75.70 $ 37.85 $ (37.85)
Unhedged ARS Assets $ 32.30 $ 16.15 $ (16.15)
Cost of hedging $ 31.00
Total Gain/loss $ (169.00)
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After 12 months:

After 12 Months

Forward Rate Peso 1.5/USD

Spot Rate Peso 2/USD

No Hedge Rate (1:1) Rate (2:1) Net Change

Net USD Exposed Liabilities $ 302.80 $ 151.40 $ (151.40)
Net ARS Exposed Assets $ 129.20 $ 64.60 $ (64.60)
Cost of Hedging 0
Total Gain/loss $ (216.00)

Hedged (50%)

Hedged USD Liability $ 151.40 $ 100.93 $ (50.47)

Hedged ARS Assets $ 64.60 $ 43.07 $ (21.53)
Unhedged USD Liability $ 151.40 $ 75.70 $ (75.70)
Unhedged ARS Assets $ 64.60 $ 32.30 $ (32.30)
Cost of hedging $ 29.02
Total Gain/loss $ (209.02)

Hedged (75%)

Hedged USD Liability $ 227.10 $ 151.40 $ (75.70)

Hedged ARS Assets $ 96.90 $ 64.60 $ (32.30)
Unhedged USD Liability $ 75.70 $ 37.85 $ (37.85)
Unhedged ARS Assets $ 32.30 $ 16.15 $ (16.15)
Cost of hedging $ 43.52
Total Gain/loss $ (205.52)