Gm Case

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“Liability Management at General Motors"
Mr. Bello was in charge making the decision of whether or not it was ideal to modify GM’s interest rate exposure, and how. If he did nothing, it would insulate GM’s cash flows fully from any interest rate exposure if they locked in at a rate of 7.63% plus transaction costs. However, they would not be able to lower the cost of debt in the event that interest rates declined. If he went with Swaps, they would use the current 6-month LIBOR rate of 4.31%, which was likely never to go below 4%, making them unsuitable for insulating GM’s cash flows. The option on treasury notes would flatten the long-term yield curve, and the long-term yield rate was to remain high above the current level. Price at maturity would operate below the bull spread making this option also not suitable for GM’s interest rate exposure. If GM opted to do benchmark caps, selling a cap with an exercise price of 10% would meet GM’s objective about 65% of the time, however there is a huge risk of unlimited losses at interest rates above 10%. Still, this is not a bad option. Swaptions are another option that isn’t terrible for GM. This option protects GM pretty well because if interest rates are high gm would be paying higher floating rates, however they’d be offset by the premium received for selling the option. If interest rates were low, the swaption would not be exercised, and GM would again be paying the fixed rate obligation, but lowered costs of borrowing by the amount of the premium that was paid. However, t here would be unlimited losses if interest rates rise above 9.4% for a 2-by-5 option and 9.64% for a 3-by-5 swaption. The best recommendation for GM to stay consistent with their core principle for risk manage, which is to reduce the variability of GM’s cash flow and lower financial distress, would be to issue the $400 million note without any derivatives. This would insulate cash flow from interest rate risk. All of the other options...
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