Foreign Exchange Hedging Strategies at General Motors Case Study Please download and review the Questions GM Case Study.doc file which contains questions t

Foreign Exchange Hedging Strategies at General Motors Case Study Please download and review the Questions GM Case Study.doc file which contains questions that needs to be answered.

This is finance related that goes in hand with economics on the basis of foreign currency exchange.

An excel file is attached GM Case Study.xls that contains important information you will need. Please work out the GM template.xls and submit that with the final Word Document you will submit.

This is not an essay rather a question and answer type paper.

Sample Question:

Present the earnings per share impact of different hedge ratios for the CAD under different exchange rate scenarios in your spreadsheet (Excel file). Should GM deviate from its policy in hedging its CAD exposure? Why or why not? Please read the Foreign Exchange Hedging Strategies at General Motors.pdf file and answer the
following questions. Each answer should be a paragraph each
Question 1:
What do you think of GM’s foreign exchange hedging policies? Would you advise any changes?
To help answer this question start to fill in the following table and it might help you understand
GM’s hedging policy
What to hedge
How much to hedge
How to hedge
Where to hedge
When to deviate
Question 2
Present the earnings per share impact of different hedge ratios for the CAD under different exchange
rate scenarios in your spreadsheet (GM Template Excel file). Should GM deviate from its policy in
hedging its CAD exposure? Why or why not?
Please Note:
a. Correction of the case: please add the following to the first full paragraph on page 9)-Additionally, Ostermann wanted his analysis to reflect the “excess cash” of CAD 660 million
held by GM Canada. Total cash or cash equivalents held by GM Canada was CAD 683;
Ostermann estimated CAD 660 of this amount was “excess cash.”
i.
We need to identify the excess CAD cash position as a hedging device too—it is
a long position that offsets the short position from transaction exposure.
b. See the template for more hints…
Question 3
Why is GM worried about the ARS exposure? What operational decisions could it have made or now
make to manage this exposure? (Check exhibit 12 and 13—what are the forward rates telling you?
Recall that we learned that forward rates capture market expectations of future exchange rate
movements? What does this mean for how expensive hedging is by this time? Indeed, this is why
anticipatory risk management is so critical—when hedging a risk is the most desirable, the cost of that
hedge rises substantially too. Good news is that there are some non-financial alternatives to hedging
this exposure…)
Question 4
Why is GM worried about the level of the yen? How would you go from the information in the case
about competitive interactions with Japanese automakers to a value exposure for GM? (i.e., assuming
JPY depreciation of 20% as in the case, what is the present value loss for GM based on all the
information given in the case—please see the template) Need to show the calculation in the
spreadsheet as well (GM Template Excel File)
Foreign Exchange Hedging Strategies at General Motors
Harvard Business School Case 204-024
Course Software 205-702 (Version 2, rev. 5/9/05)
This course software was prepared solely as the basis for class discussion. Cases are not intended to serve as
endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright ©
2004 President and Fellows of Harvard College. No part of this product may be reproduced, stored in a
retrieval system, used in a spreadsheet or transmitted in any form or by any means—electronic, mechanical,
photocopying, recording or otherwise—without the permission of Harvard Business School.
Exhibit 1 GM Consolidated Income Statement
December 31,
($ millions)
Total net sales and revenues
Cost of sales and other expenses
Selling, general, and administrative
Interest expense
Earnings before taxes and minority interests
Income tax expense
Equity income (loss) and minority interests
Income from discontinued operations
Net income
Dividends on preference stocks
Earnings attributable to common stocks
2000
184,632
145,664
22,252
9,552
7,164
2,393
-319
4,452
-110
4,342
1999
176,558
140,708
19,053
7,750
9,047
3,118
-353
426
6,002
-80
5,922
Source: General Motors, December 31, 2000 10-K (Detroit: General Motors, 2001).
1998
155,445
127,957
15,915
6,629
4,944
1,636
-259
-93
2,956
-63
2,893
Exhibit 6 GM’s Largest Currency Exposures (Forecasted Receivables Less Payables)
As of
12/31/00
$0
USD
EUR
JPY
GBP
SEK
AUD
CAD
CHF
GMNA
800
(400)
–
–
(200)
–
(1400)
–
GME
400
(2400)
(200)
1400
(800)
400
(200)
400
GMAP
200
(200)
(200)
200
–
200
–
–
GMLAAM
600
(400)
(500)
–
–
–
–
–
GM Total
2000
(3400)
(900)
1600
(1000)
600
(1600)
400
Source: General Motors
Figures have been disguised and do not reflect the actual operations of General Motors Corp.
NOTES:
GMNA: General Motors North America
GME: General Motors Europe
GMAP: General Motors Asian Pacific
GMLAAM: General Motors Latin America, Africa, Middle East
PLN
MXP
OTHER
–
1200
–
200
–
800
–
–
200
–
–
–
200
1200
1000
Exhibit 9 GM Canada – Projected Cash Flow Exposure
Cash Flows
INFLOWS
Canadian sales
Tax refunds (GST)
OUTFLOWS
Material purchases
Capital expenditures
Other structural costs
Tax expenditures
Other expenditures
12 month C$ cash flow forecast
Amount as of September 30, 2001
10,564
1,049
(10,180)
(113)
(1,737)
(1,258)
(6)
(1,682)
Source: Company documents.
Figures have been disguised and do not reflect the actual operations of General Motors Corp.
Exhibit 10 GM Canada – Net Monetary Asset/Liability Exposure
Balance Sheet Account
Amount as of September 30, 2001
ASSETS
Cash & cash equivalents
683
Accounts & notes receivable
271
Deferred income taxes
118
Pension asset
1525
LIABILITIES
Outside – all other
Other postretirement benefits
Warranty
(93)
(1,949)
(132)
Accounts payable and other
(2,565)
C$ Monetary asset / (liability) position
(2,143)
Source: Company documents.
Figures have been disguised and do not reflect the actual operations of General Motors Corp.
Exhibit 11 GM Argentina Balance Sheet, Monetary Assets and Liabilities by Currency, as of September 30, 2001
ARS Monetary Assets
ARS Monetary Liabilities
Scrap incentive owed by govt.
45.8
Payables to local suppliers
24.1
Interest subsidy owed by govt.
3.2
Provisions to local suppliers
11.3
ARS loan (VAT financing)
13.7
VAT credit and other tax owed by govt.
130.6
Receivable (tax credit reimbursement)
2.7
Other provisions
Other
7.8
Tax payable
Total
190.0
USD Monetary Assets
Cash
Total
9.8
2
60.9
USD Monetary Liabilities
2.5
Accounts payable
224.5
Receivables
20.5
Loans
101.3
Total
23.0
Total
325.7
Source: Company documents.
Figures have been disguised and do not reflect the actual operations of General Motors Corp.
Exhibit 13 Cost of Hedging the ARS Exposure in Argentina
Time Horizon / Hedging Period
Cost
($ millions)
One-month Forward
$6.4
Three-month Forward
18.2
Six-month Forward
28.7
Twelve-month Forward
40.3
Source: Company documents.
Exhibit 15 General Motors Investments in Japanese Automakers
Affiliate Exposure
Long/(Short)
($ billions)
GM
OwnershipStake
Fuji
(1.50)
20%
Isuzu
(1.02)
49%
Suzuki
(0.09)
20%
Affiliate
Source: Company documents.
Figures have been disguised and do not reflect the actual operations of General Motors Corp.
Exposures are net yen exposures (measured in dollars) and are presented for each affiliate entity. For
example, Fuji’s yen-denominated liabilities exceed its yen-denominated assets by $1.5 billion. GM’s
exposure is limited by the relevant ownership share in the affiliate.
expected volatility
Spot CAD/USD
CAD stronger
CAD weaker
Translation exposure
CAD/USD
Underlying translation exposure in CAD
USD value
Pretax impact on GM of exchange rate movement
Number of shares outstanding
Pretax EPS impact
Transaction exposure
CAD/USD
Underlying transaction exposure in CAD
USD value
Pretax impact on GM of exchange rate movement
Number of shares outstanding
Pretax EPS impact
Hedging position
(1) 50% policy on transaction exposure
Hedge ratio
Required hedge (CAD-long)
Existing long position (excess cash)
Hedge put in place
Value of hedge in USD
Hedge gains/losses due to exchange rate movement
Number of shares outstanding
Pretax EPS impact
(2) 75% policy on transaction exposure
Hedge ratio
Required hedge (CAD-long)
Existing long position (excess cash)
Hedge put in place
Value of hedge in USD
Hedge gains/losses due to exchange rate movement
Number of shares outstanding
Pretax EPS impact
3.10%
1.578
1.5291
1.6269
Rate scenarios
Spot CAD/USD
-baseline
scenario
CAD stronger
CAD weaker
1.578 1.529082
1.6269
-2143
-2143
-2143
1.578 1.529082
-1682
-1682
1.6269
-1682
50%
50%
50%
660
660
660
75%
75%
75%
Hint
Exhibit 10
Row 8/row7 (e.g., -2143/1.578 for B9)
difference from baseline result B9 (e.g., C10=C9-B9)
Page 9-first full paragraph
row 10/row 11
Exhibit 9
calculation same as translation exposure above
hedge ratio*transaction exposure in offsetting position (e.g., B27=1682*50%)
identify cash position as a hedging device–cash amount of 683 is from Exhibit 10, but excess cash is 660
required hedge-existing hedge (e.g., B29=B27-B28)
row 29/row 16
difference from baseline
hedge ratio*exposure in offsetting position
identify cash position as a hedging device–cash amount of 683 is from Exhibit 10, but excess cash is 660
required hedge-existing hedge
raw 40/row 16
difference from baseline
1. JPY depreciation
2. JPY content per vehicle
3. Cost savings passed onto
consumers
4. Vehicle price reduction
5. Sales elasticity
6. Japanese annual sales in US
(units)
7. Increase in Japanese sales
(units)
8. Cross elasticity to GM
9. Loss in GM sales (units)
10. GM unit contribution margin
11. GM pre-tax loss (millions)
12. Discount rate for a perpetuity
13. Present value of loss (million)
20%
GM assumption-P. 13
Sensitivity range given in P. 13
Find the info from the case-sensitivity range given in P. 13
1*2*3
Find the info from the case text P.13
Find the info from the case P.13
4*5*6
Find the info from the case P.13
7*8
Calculated based on information in case text and Exhibit 16
9*10
Find the info from the case- first line on P.14
11/12
Foreign Exchange Hedging Strategies at General Motors
Case summary
The treasury team at General Motors (GM), headed by Eric Feldstein, is responsible for
managing the corporation’s varied financial transactions and their associated risks. GM has
implemented a number of formal policies with respect to foreign exchange risk management and
hedging procedures. These policies guided the vast majority of treasury operations, but on
occasions situations arose that required special attention and possibly a deviation from the stated
policy. Feldstein was currently reviewing three proposals for (1) the Canadian Dollar, (2) the
Argentinean peso, and (3) Japanese Yen. Feldstein and his team have to evaluate GM’s exposure
to each currency, determine the risks, consider other approaches to managing these currency
risks, and decide if GM should depart from its formal hedging policy.
The case first talks about some background information, including overview of GM and its
Treasury operations (p. 2-3), review of corporate hedging policy (p.3-6), and understanding the
choice of a subsidiary’s functional currency (p.6-8) . Please read these parts carefully as they will
help you understand the problems Feldstein is currently facing with three different problems:
1. Canadian dollar (p.8-11, Exhibit 10): the firm has a large transactional exposure to the
Canadian dollar, and a sizable translational exposure. GM must determine how
fluctuations in the U.S. Dollar/Canadian Dollar exchange rate would impact GM’s
income statement, and also consider the longer term implications of the firm’s exposure
to the Canadian dollar. We will be asked to examine the relevant accounting
consequences of the CAD currency exposure.
2. Argentinean peso (p.11-12, Exhibit 11-13): GM has to decide how GM should deal
with the widely anticipated devaluation of the peso. Would it be cost effective for GM to
hedge more of its exposure, or are there other actions that GM might take to mitigate the
effects of a peso devaluation? The ARS exposure illustrates some lessons about risk
management in the face of an imminent devaluation. Exhibit 11 illustrates the nature of
the exposure to ARS (long peso, short dollar). Exhibit 12 and 13 show the cost of
hedging at this time.
3. Japanese yen (p.12-14, Exhibit 14-16): Although GM sells few cars in Japan, GM has a
significant competitive exposure to the yen. An anticipated depreciation of the yen
against the U.S. dollar would give Japanese automakers a sizable cost advantage relative
to GM in the U.S. market, thus allowing them to take market share away from GM and
other U.S. car makers. GM’s competitive exposure to the yen is a long-standing strategic
concern among GM executives, but discussion on what to do about it have been largely
hypothetical. Therefore, Feldstein aims to develop an analytic framework to quantify
GM’s yen exposure to allow GM to better manage the risks.
Learning objectives
1. Examine the reason for hedging
2. Identify the different types of exchange rate risks faced by companies with international
operations
3. Understand the decisions that have to be made to construct a hedging policy and evaluate
one such policy
4. Analyze how changes in exchanger rates affect a company’s financial statements using
GM’s exposure to the Canadian dollar
5. Compare the use of futures and options in implementing hedges
6. Evaluating risk management decisions in more extreme setting of an imminent
devaluation
7. Identify the sources of competitive exposures
8. Examine different methodologies for quantifying competitive exposure
9. Explore how competitive issues have financial consequences
Assignment questions (15 points each)
1. What do you think of GM’s foreign exchange hedging policies? Would you advise any
changes? (To start, fill in the following table and it might help you understand GM’s
hedging policy…)
What to hedge
How much to hedge
How to hedge
Where to hedge
When to deviate
2. Present the earnings per share impact of different hedge ratios for the CAD under
different exchange rate scenarios in your spreadsheet. Should GM deviate from its policy
in hedging its CAD exposure? Why or why not?
Note:
a. Correction of the case: please add the following to the first full paragraph on page
9)–Additionally, Ostermann wanted his analysis to reflect the “excess cash” of CAD
660 million held by GM Canada. Total cash or cash equivalents held by GM Canada
was CAD 683; Ostermann estimated CAD 660 of this amount was “excess cash.”
i. We need to identify the excess CAD cash position as a hedging device too—it
is a long position that offsets the short position from transaction exposure.
b. See the template for more hints…
3. Why is GM worried about the ARS exposure? What operational decisions could it have
made or now make to manage this exposure? (Check exhibit 12 and 13—what are the
forward rates telling you? Recall that we learned that forward rates capture market
expectations of future exchange rate movements? What does this mean for how
expensive hedging is by this time? Indeed, this is why anticipatory risk management is so
critical—when hedging a risk is the most desirable, the cost of that hedge rises
substantially too. Good news is that there are some non-financial alternatives to hedging
this exposure…)
4. Why is GM worried about the level of the yen? How would you go from the information
in the case about competitive interactions with Japanese automakers to a value exposure
for GM? (i.e., assuming JPY depreciation of 20% as in the case, what is the present value
loss for GM based on all the information given in the case—please see the template)
Note:
1. For the case, you do NOT need to write an executive summary or case report, as
your other classes may require. Instead, I will assign you several questions as
above. You need to answer each question with sufficient supporting details (e.g.,
your excel worksheet, your calculation process, the economic theory/concept…).
2. We have various background coming into the course– some of you might had
pretty good knowledge of exchange rates already, while others might just get
started on exchange rate this semester. For those of you who might feel
overwhelmed by the more complicated case here, my suggestion is to first go over
the practice problems, which have some simpler situations. Madura has a simpler
case about managing transaction exposure on Page 363-365, and I have posted the
answers. Although not required, please go over them and they will help you
approach the more complicated situations in the GM case. As you see, the beauty
of these simpler problems/cases is the clarity they offer, which will help our
understanding of the basic issue, but the sad news is that clarity is rare in real life
situations. That’s why we need to take a step further to work on more complicated
and also more real-life-like cases?

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