What was the stated objective of General Motors Risk Management policy? Three primary objectives: 1) Reduce cash flow and earnings volatility – this means management hedges the company’s transaction exposures and deliberately pays no attention to any balance sheet exposures or translation exposures. 2) Minimize the management time and costs dedicated to global FX management – this is as a result of an internal study that determined that the investment of resources in active FX management had not resulted in significant outperformance of passive benchmarks.An active approach was implemented.
3) Align FX management in a manner consistent with how GM operates its automotive business – this was an effort to plan to the geographical operational footprint of the underlying business. The passive policy implemented by GM is to hedge 50% of all major foreign exchange commercial or operating exposures. Regional treasury had the following guidelines: invest in forward contracts to hedge 50% of the exposures for the first six months and options to hedge 50% of the exposures for the remaining six months.Finally, to assure flexibility, at minimum of 25% of the combined hedge on a particular currency is to be in options. Though GM had implemented prescribed policies that guided the majority of treasury operations, there were suggestions for the Canadian dollar, Argentinean peso, and Japanese yen that were situations that required departure from these formal policies. Define and demonstrate the source or sources of group risk. Be sure to provide justification for your assertions from the case data. The following highlights sources of risk for the proposals outlined for Canadian dollar, Argentinean peso, and Japanese yen.
The CAD is weak and the concern lies in that if it strengthens given that the primary operating currency is USD and a large amount of GM-Canada’s assets and liabilities are in Canadian dollars. An appreciation in the CAD would result in increased payable cash flows in the form of future pension and post retirement debt Canadian employees, and payments to Canadian suppliers. Additionally, there would be an impact on the value of outstanding contracts, labor rates, cost of goods sold, and decrease in sales, profit margin and decrease in market share GM’s current hedging policy was 50% on the CAD 1.
billion cash flow exposure that was projected of 12 months. The proposal was to increase the hedged amount to 75% which was the maximum allowed on GM’s policy. I support the proposal for the following reasons: 1) Historically seeing CAD denominated supplier payments higher than CAD denominated sales 2) Increasing the hedging ratio to 75% would reduce the CAD/USD exchange rate 3) Increasing the hedging ratio to 75% would reduce the unpredictability of global earnings 4) Increasing the hedging ratio to 75% would reduce EPS unpredictabilityIn terms of translation risk, one possibility to mitigate the risk would be to select a spot rate or an exchange market price at which the value of the assets in CAD (2,597 per exhibit 9) could be sold. Argentina and the Peso A primary sources of transactional risk in Argentina is the widespread inflation. The government maintained a peg to the U. S.
dollar at USD 1: ARS 1, however, the 2001 “zero deficit” law put Argentina at risk at defaulting on its debt; a debt to GDP ration of 45%; $16. 5B.The short term possibility that Argentina would default on its debt had reach 40% and in the medium term it reached 50%. A default would result in a devaluation of the Argentinean Peso. The devaluation would result in losses on the income statement, the doubling of net liabilities from USD$300MM to USD$600MM and a decrease in cash flows. GM could hedge to protect a future period against the possibility of the devaluation of the Argentinean Peso by selling it forward and buying it forward. Another hedging approach to take into account the ARS assets totaling 190 and liabilities totaling 60.
that are at exchange rate risk would be to convert ARS assets to USD. Similarly to mitigate some translation risk for the CAD GM could select a spot rate at which the value of the assets in ARS (190 per exhibit 11) could be sold. Japanese Yen GM was exposed to competitive risk as a result of competing against companies with different home currencies. The possibility of the Yen devaluing would result in an increase in the competitors’ gross margin, which was dominated in Yen. For every 1 Yen depreciation Japanese operating profit grew by $400MM.The newly realized gross margins would allow for savings that would be passed along to the consumer in the form of lower prices, positioning GM as a competitor with higher prices.
The change in pricing structures would create a rippling affect in consumer purchasing decisions, which in the medium and long term would impact GM market share and value. Other sources of exposure included investment exposure in the form of GM’s accounts receivables and payables in the amount of $900MM, financing exposure as a result of a Yen dominated loan; and Yen bond issue with $500M in bonds outstanding.Overall, I would recommend that the hedging policy be updated to include policies that take into account the balance sheet or translation risks that the current policy ignores. The combination of both transaction and translation hedging would reduce GM’s overall risk exposure. Also, as done in the hedging workshop question, based on confidence in sales forecasts and historical trends, to manage their risk GM could hedge 75% of sales in Canada, Argentina and Japan with 6 month forwards and the remaining 25% of sales for each could be hedged at 50% with both a Put and a Call to reduce the premium cost.