Foreign Exchange Hedging Strategies at General Motors: Transactional and Translational Exposures

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General Motors was the world’s largest automaker and, since 1931, the world’s sales leader. In 2001, GM had unit sales of 8.5 million vehicles and a 15.1% worldwide market share. Founded in 1908, GM had manufacturing operations in more than 30 countries, and its vehicles were sold in approximately 200 countries. In 2000, it generated earnings of $4.4 billion on sales of $184.6 billion. The company is trying to accurately calculate the risk of a potential devaluation to the ARS. In doing so the company had to decide between two options on how to proceed; was it worth the costs to increase the size of GM’s hedge position beyond the standard policy or should GM Argentina rely on other approaches to cope with the expected devaluation?

Appraisal of GM’s Passive Hedging Strategy

GM’s passive hedging strategy is reflective of its policy to focus on its underlying business rather than speculate on the movements of foreign currency. There are two main types of currency exposure. The first being economic risk. This deals with the impact of devaluation on the present value of the future earnings of the firm. It is very difficult to measure this concept because it depends on the reaction of the competitive context of the firm and the effect of the currency shock over competitors and customers. The second risk is the transaction exposure which is easier to measure and to hedge. Translation exposure or cash flow exposure concerns the actual cash flow involved in settling transactions denominated in foreign currency. Firms seldom hedge against balance sheet or translation exposure for two reasons; devaluating in one currency could be compensated with revaluation in another and in the long term assets and net worth would not be affected by currency volatility because exchange rate movements mainly depend on productivity.

GM’s current policy is to hedge 50% of all significant foreign exposure on a commercial level. The majority of volatility reduction is achieved with the first 50% of hedging, after which the pace of risk reduction diminishes quite quickly. From a behavioural finance perspective a %50 hedge is the position of least regret for short term fluctuations i.e. could have been better, could have been worse In our opinion GM is in general hedging too much using financial instruments which is a costly method. The company could look into internal hedging i.e. leading and lagging or commodity hedging. Natural hedging is also an option which is also discussed later in our report. They also hedge regionally where they should have a centralised hedging policy where the residual risk can be calculated and hedged.

We would advise GM to not use an active hedging strategy as their focus is on selling units and not making a profit from currency management. It is clear from their risk management objectives that they are risk averse. Their interest is in stable cash flows and not speculating on the volatility of currencies which is represented in their use of a passive strategy.

Hedging decisions need to be placed with the centralised Risk Management Committee. This will allow GM to maximise netting opportunities while minimising idle balances in non-functional currencies. It is also beneficial for parent treasuries to be assisted by foreign hedging centres that relay information back to headquarters. Even companies that do not have centralised FX risk management undertake various activities to reduce individual FX trading among the operating units. ‘For example, if with respect to the British pound GM-Europe had a net receivables position $1 million and GM-Asia Pacific had a net payables position of $1 million, each regions GBP exposure would be hedged even though GM as a consolidated entity had no net exposure before or after this hedging activity took place.’(Note 8) Such problems would be eliminated using a centralised approach

Under what circumstances should GM deviate from its formalized hedging policy?...
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