Foreign Exchange Hedging Strategies at General Motors
Added on 2020-01-28
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Que. 1 Explain and discuss the foreign exchange transaction exposure management by GeneralMotors by analysing data and information from the case study.Answer:General Motors (GM) operates all its foreign exchange operations from two plants and itshedging activities were also concentrated with these two centers. First is the Domestic Financegroup in New York. This center handled FX hedging for General Motors entities located inNorth, Latin and the Middle East of America and Africa. Second is the European RegionalTreasury Center (ERTC) and it is one of the large exchange operations of General Motors. Thiscenter covers FX exposures of European and Asian continents’ countries. While reviewing the corporate hedging policy of the company it is determined that overallforeign exchange risk management policy was established to achieve primary objectives of thecompany (Hawkins, 1995). First objective set by the company is to reduce the cash flow andearnings volatility. Second objective, company need to reduce the management time and costsused for global FX management. Thirdly, FX management is aligned in such way that it shouldwork consistent with GM’s automotive business. Regarding this context General Motors adoptedthe passive policy where hedge is 50% of commercial or operating exposures. Company’s policyalso determined the sort of derivative instruments that were needed to use for hedging. Riskinesswas determined on the basis of region to decide which FX exposures were crucial enough towarrant hedging. Commercial (operating) exposures: Risk is determined on regional basis and it also decides thesignificant FX exposures to warrant hedging (Bartram, Sohnke, Burns and Helwege, 2013). Tomake this risk determination following formula is used Implied risk = Regional motional exposure x Annual volatility of relevant currency pairFor example: The devaluation of euro (foreign exchange currency) may not have impact onfunctional currency but there is different in the impact recognized in income statement andshareholders’ equity. Let us consider a case, where GM is investing in Japanese market. According to the roughestimates of reports and marker research the automobile firms in Japan were run unprofitable
though yen was 110 and stronger than dollar. To become profitable Japanese firm need yenvalue at 120 or more as compare to dollar. Japanese car has near about 20% to 40% Japanesecontent and hence market share loss would equally affect its partnering organization. Roughcalculation implies that around 20% yen devaluation can capture an upper bound of the likelyforeign exposure. A consequent annual impact on GM's Income Statement could then be valuedas perpetuity at a 20% discount rate.Commercial exposures (capital expenditures): Capital expenditure cannot be exhibited onmonthly basis for volatility or changing forecasts and hence General Motors have adopted aunique approach to hedge capital expenditure. The planned investments which meet thefollowing two tests were hedged with forward contracts and the hedge ration used was 100% tothe anticipated payment date. The two tests are; 1) Amount in excess of $1 million, or 2) Implied risk equivalent to at least 10% of the unit net worth. Financial exposures: The cash flows which incorporates loan repayment schedule and equityinjections need to be hedged on case-by-case basis and it is the main base of financial exposure. Translation (balance sheet) exposures: This was not incorporated into the hedging policy ofGeneral Motors Accounting treatment: General Motors’s were constantly trying to reduce its earnings volatilityand it is one of the objectives of foreign exchange risk management policy. This is challengingfor GM to implement, because it requires that, according to the prevailing accounting standards(FAS 133), GM income statement need to use marked-to-market and the gains and losses flow. Qns 2) Explain and discuss (Using theories) the foreign exchange hedging strategies used by General Motors for translation and economic (competitive) exposures. Ans) The overall foreign exchange hedging policy of General Motors was established on the basis of following objectives: -
1)For reducing the earning volatility and the cash flow.2)For minimizing the costs of dedication to the global FX management and the time consumption in the management process. 3)To align the management of FX in the way General Motors operates as its automotive business. Translational exposureThere is use of balance sheet hedge for typically mitigating the translation exposure as faced by the General Motors Argentina. This theory requires an equal amount of foreign currency assets and liabilities on GM’s consolidated balance sheet. There is a justification of the balance sheet hedge: -1)The use of local currency by the GM Argentina to use as a functional currency in that country. 2)The operation of the company is on the basic of hyperinflationary environment. This strategy is successful when it is depended on the precise prediction of the future exchange rates. There is no possible future for such a hedge based on the future spot rates. It will contribute in increasing the tax burden since the profit which gained from the forward hedge is taxable. Competitive exposure It is the exposure which results in competing against companies with different currencies of different countries. Like the Japanese automakers and the depreciation of the yen. The operation of the company is affected by the risk of current and eroding market share and the value of the
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