Gm Hedging Strategies Yen

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Foreign exchange hedging strategies at General Motors|
Competitive exposures|
Project on International FinanceMar 2011|
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Overview of General Motors and its corporate hedging policy

General Motors was the world’s largest automaker and since 1931, the world’s sales leader. In 2000, it had a net income of $4.4 billion on revenues of $184.6 billion. North America represented the majority of sales to end customers but international operations were also growing and international sales had reached 18% of overall sales. The key objectives of GM’s foreign exchange risk management policy was to reduce cash flow and earnings volatility, minimize management time and costs dedicated to FX management and align FX management in a manner consistent with how GM operated its automotive business. GM hedged only cash flows (transaction exposures) and ignored balance sheet exposures (translation exposures). A passive hedging policy of hedging 50% of all significant foreign exchange exposures arising from receivables and payables was adopted. Forward contracts were used to hedge exposures arising within six months and options used to hedge exposures arising within seven to twelve months. GM’s overall yen exposure included a commercial exposure based on forecasted receivables and payables of $900 million, an investment exposure resulting from equity stakes in Japanese companies and financing exposure through a yen-denominated loan.

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GM’s competitive exposure

GM’s competitive exposure to the yen arose because of competing against Japanese automakers who had large parts of their cost structure denominated in yen. Any fluctuation in the dollar/yen exchange rate affected the operating profits of Japanese automakers significantly, since they derived 43% of their revenue from the US markets (as of 2000). The yen appreciation from 117 to 107 during the first half of 2000 had reduced their combined global operating profit by nearly $4 billion. In the second half, the yen had begun appreciating. GM needed to quantify this competitive exposure and effectively hedge it.

Depreciation of the yen would lead to reduced costs for Japanese automakers (since 20% to 40% content was sourced from Japan). 15% to 45% of this cost saving would be passed on to the customer. Customer sales elasticity as measured by GM indicated that a 5% price decrease would increase unit sales by around 10%. This market share gain by Japanese automakers would be shared equally and entirely by the Big Three in Detroit. -------------------------------------------------

Quantifying GM’s competitive exposure

Assumptions:
* Japanese car makers source 40% content from Japan (worst case scenario). * 45% of cost savings is passed on by Japanese carmakers to customers (worst case scenario). * Yen devaluates by 20% compared to the dollar(worst case scenario). * Total cost per car is $20000 (assumed). The margin obtained by GM is approximately $5900 ($1969 * 3) on the cost. Due to competition, Japanese carmakers would also need to price their vehicles similarly. Hence the same price is assumed for Japanese carmakers as well. * Loss is valued as a perpetuity at 20% discount rate.

 | Japanese carmakers| General Motors|
 |  |  |
Cost of Car| $20,000|  |
Price of car| $25,900|  |
Component cost (of Japanese component) at old exchange rate of $1=100¥ (40% components sourced from Japan)| ¥800,000 = $8000|  | Component cost at new exchange rate of $1=120¥| ¥800,000 = $6,666.67|  | Change in profit margin| $1,333.33|  |

Addl. Margin passed on to customers ( = 45% of change in profit margin)| $600.00|  |  New price of car| $25,300|  |
Price decrease| 2.32%|  |
Increased sales (elasticity = 2)| 4.63%| |
Sales in 2000| 4100000|  |
Increase in sales in 2001 (Gain by Japanese carmakers shared by Big...
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