Foreign Exchange Hedging Strategies at General Motors: Transactional and Translational Exposure
In September of 2001 General Motors (GM) was faced with a billion dollar exposure to the Canadian dollar. At the time, North America represented approximately three-quarters of GM’s total sales and this large exposure to the CAD could significantly affect GM’s financial results. GM had a passive strategy of hedging 50% of its exposure; this paper explores the impact of hedging 75% of the exposure. Additionally, GM faced a unique problem in Argentina, which was at risk of defaulting on its international loans. A default would also cause the Argentine Peso to be devalued from 1 peso to 1 dollar to 2 pesos to 1 dollar, a substantial change. The chance of the default was estimated to be 40 to 50%. While the exposure was smaller than Canada, it was still significant at $300 million.
GM has had foreign currency exposure risks for decades. These foreign currency exposures are related to buying, selling, and financing in currencies other than the local currencies in which they operate. Derivative instruments, such as foreign currency forwards, swaps and options are used primarily to hedge their exposures with respect to forecasted revenues, costs and commitments noted in foreign currencies (Wagoner, pg 134). These contracts generally mature in approximately 32 months. As of December 2008, GMs three most significant foreign currency exposures were the U.S. Dollar/Korean Won, Euro/British Pound and U.S. Dollar/Canadian Dollar (Wagoner,134). GM is also exposed to foreign currency risk in other ways; namely, as they convert the results of the international operations into U.S. dollars as part of their consolidation process. Variation in exchange rates can consequently create instability in the results of GM operations and may unfavorably affect their financial position. For example, the effect of exchange rate translations on the consolidated financial position for GM for 2008 was a net translation loss of $1.2 billion (Wagoner, 135). For GM, this loss can be recognized as an adjustment to the Stockholders’ deficit through accrued or other comprehensive loss. For GM, their operating exposures are the effect of change in exchange rates in the expected value of a firm’s future operating cash flows (Case Study). Transaction exposures are the gains and losses that arise when transactions are settled in a currency other than the company’s reporting currency. These transaction exposures usually come from buying and selling activities. Translational exposures are the gains and losses that arise when a company’s assets and liabilities of the multinational’s foreign subsidiary are translated back into the reporting currency, in regard to intentions of preparing financial statements.
Review of Hedging Strategy
The foreign exchange hedging policy of GM has 3 primary objectives: 1. To reduce cash flow and earnings volatility
2. To minimize the management time and costs dedicated to global foreign exchange management 3. To align foreign exchange management with the firm’s core automotive business For General Motors, their passive hedging strategy is in direct correlation to their policy to focus on the underlying business of manufacturing and selling automobiles, rather than to hypothesize on the movements of foreign exchange rates and policies. This gives each of the treasury departments within the regional GM offices the ability to be provided with specific guidelines based on their designated functions. Below you will see a brief description of each of the objectives of the GM Hedging Strategies. 1. To reduce cash flow and earnings volatility
In regard to reducing cash flows and earnings volatility, management at GM is working hard by hedging the company’s transaction exposure to exchange rate risk. They continue to ignore any exposures to the balance sheet and focus...
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