Foreign Exchange Hedging Strategies at General Motors

Topics: Foreign exchange market, Exchange rate, Currency Pages: 20 (2786 words) Published: October 26, 2012
FX Hedging:10 Common Pitfalls

A Structured Approach to Financial Risk Management

Executive Summary

1 Unclear Risk Management Objectives

3 Absence of Appropriate Performance Benchmarks

The design and implementation of an effective FX risk management

In order to design an effective FX hedging strategy, it is

With almost any business activity, performance

necessary to know exactly what the strategy is intended

measurement is essential to determine the effectiveness

to accomplish. While this may appear to be self-evident,

of a chosen strategy. If a company’s marketing department

volatility experienced in the foreign exchange markets over the past

the process of determining a company’s FX hedging

designs a new advertising campaign, the impact of that

couple of years has highlighted the need for large and small businesses

objectives is not always as straightforward as it sounds.

campaign on future sales will be closely monitored to

Stating a simple objective, such as “protecting the business

determine whether the campaign should be continued.

from FX volatility” may be stating the truth, but it is not

And just like the decision to launch a new advertising

specific enough to effectively guide the design and

campaign, the determination of an FX hedging strategy is

implementation of an FX hedging strategy. Is the goal to

a key strategic decision, which can have a material impact

protect the balance sheet or the P&L? Should accounting

on a company’s bottom line. As such, it is important that

results be prioritised over cash flow impacts? What is the

a system is in place which allows the performance of the

relevant time horizon? These are the types of questions

hedging strategy to be measured.

strategy can be a challenge for many businesses. The extreme level of

to carefully consider their FX hedging requirements, and whether their current hedging programs are sufficient to meet their risk management objectives. This white paper highlights 10 key pitfalls that companies should be aware of when evaluating their current hedging strategy.

that must be answered to allow the design of an effective

FX Hedging - 10 Common Pitfalls

hedging strategy.

The choice of benchmark is also critical, and should be
closely linked to the objectives of the hedging strategy.

A company’s risk management objectives represent the

1. Unclear Risk Management Objectives
2. Lack of Structured Hedging Strategy
3. Absence of Appropriate Performance Benchmarks

If, for example, the objective of the hedging strategy is

foundation of its FX hedging strategy. As such, these

to ensure that a company achieves its quarterly budget

objectives should be closely aligned with the overall business

rate, then the benchmarking metrics must also include

strategy, and they should be clear, specific and measureable.

the achievement of this objective. If the hedging strategy

2 Lack of Structured Hedging Strategy

is designed to incorporate a “market view”, then the
benchmarking system should include a metric that compares
the achieved rate to a relevant passive hedging portfolio.

The reluctance of many companies to adopt a formal,

4. Allowing a “Market View” to Drive Strategic Hedging Decisions

7. Failure to Consider Internal Risk Reduction Opportunities 8. Failure to Consider the Impact of Correlations between Exposures

system will usually result in the “success” of the hedging

FX markets is paramount, and formal hedging polices may

strategy being determined by reference to inappropriate

be seen as cumbersome and bureaucratic. However, lack of

6. Inefficient Pricing of Hedging Instruments

Failure to implement an effective benchmarking

need to remain flexible when managing risk in the volatile

5. Use of Complex Derivatives as Hedging Instruments

documented hedging strategy is perhaps understandable, as...
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