General Electric's Yen Payables

In January 2009 Bill Straub, the finance manager of the DVD division of the company
was confronted with a nasty dilemma: what to do with a big chunk of yen payables that
his unit accumulated in the course of its business which consisted of marketing a line of
video tape recorders under the G.E. label in the United States. Like all video tape
recorders sold in the U.S. market, G.E.'s were also made in Japan by one of the four
manufacturers that dominate the business and its associated technology. Steady advances
in that technology and production processes had put DVDS prices on a long term
downward trend of approximately 12 percent p.a., a trend that was expected to continue
(see Figure). The four Japanese manufacturers sold machines under their own labels, but
they also supplied U.S. marketers who sold them under their own names, and G.E. was
one of them. Because the Japanese manufacturers had the field all to themselves, they
invoiced their customers in yen, giving customarily 90 day terms.

Bill Straub's dilemma was in part accentuated by the conditions on the distribution side of
the video tape recorder business: there were about ten competitors active in the U.S.
market, including the four captive marketing companies of the Japanese manufacturers.
During the recession, demand for video tape recorders had slowed considerably as
consumers' buying intentions had weakened. As a result of soft demand and intense
competition, margins were razor thin. In this environment, hedging costs began to matter.
To make things worse, they were at a record high: the yen had weakened a bit over the
past months from Y242 per U.S. dollar to Y250. Ninety-day forwards at this time ran at
Yen 246, reflecting approximately a 6.5 percent U.S. dollar premium to Yen when
converted to an annual basis. The cost of U.S. dollar debt at the time was 15.5 percent,
while rates for "Euroyen" (yen credits available from banks outside of Japan) were about
9 percent per annum.
In 1981, Bill's strategy of leaving the payables uncovered had turned out to be a brilliant
tactical move. Not only had the dollar value of the yen decreased, Bill's action saved the
division also 6.5 percent hedging costs per annum, as he was careful to point out in his
annual report. But now for 2009, what was he going to do as an encore? Bill recognized
that the same superiors who patted him on the back for his success, would sacrifice him
without mercy if the yen turned the wrong way. As long as that currency would
appreciate by no more than four yen for every 90 days, Bill could always argue that the
hedging cost savings equalled roughly the translation losses. However, a glance at the
historical evidence told him that the Japanese currency was given to abrupt swings and
Bill was not sure whether this was not the time when caution was the better part of valor.
Since any hedging strategy would represent a major change in financial policy for the
division, Bill recognized that he had to do some selling inside. In particular, the people
that mattered had to be told about the accounting and cash flow implications as well as
the various hedging alternatives.

Could you help Bill prepare his presentation?