Being one of the largest automakers in the world, General Motors (GM) undertakes its manufacturing operations in over 30 countries with vehicles being sold in over 200 countries. Through undertaking its international operations it also subjects itself to various types of foreign exchange exposures due to fluctuations in the values of currencies; to manage this problem it has adopted a passive hedging policy and aims to reduce the impact of foreign exchange exposures on the business.
The first part of this report outlines the various types of foreign exchange exposures that GM can subject itself to and also outlines what methods can be used to reduce the risk associated with changes in the value of currencies; the policies adopted by GM are then outlined and the strategic decisions required in ensuring the viability of the policies. An assessment of GM’s hedging policy is then made and various points are outlines in regards to potential improvements that can be made ranging from how options are exercised to whether translation exposures should be included in the hedging policy.
One of the key exposures facing GM is the Canadian Dollar Exposure. This exposure was incurred as a result of changes in accounting standards; that required GM Canada to assign the US dollar as its functional currency due to the large number of assets denominated in the currency. GM’s policy specifies that it should only hedge 50% of its commercial operating exposures and translation exposures should not be hedged. Whereby the CAD exposure is CAD 1682 Million, it would have a significant impact on the firm, more so due to the CAD 2143 million translation exposure, thus a solution is posed as to whether the policy should be adapted to 75% hedging in order to reduce risk.
The possible devaluation of the Argentinean Peso from ARS 1:$ to ARS 2:$, also has a significant impact on GM due to its operations in Argentina. The exposure which is purely translation in respect to the parent company is not hedged according to the policies; and would incur a loss of $64.6 million if the devaluation was to take place. To ensure this risk is reduced, it would be viable for GM to hedge this exposure either through the use of forwards or by using non-financial instruments such as changing the functional currency.
1. Foreign Exchange Exposure and Risk Management
1.1 Types of Foreign Exchange Exposure
There are three predominant types of financial exchange exposure which multinational entities face as a result of foreign exchange rate movements, these are: Transaction Exposure, Operating Exposure and Translation Exposure. •
Transaction Exposure – measures the change in outstanding financial obligations made prior to change in exchange rates but due to be settled after changes in exchange rates take effect. Deals with cash flows as a result of contractual obligations (Eiteman, Stonehill and Moffett, 2010). •
Operating Exposure – measures the change in the present value of the firm resulting from changes in the expected future operating cash flows of a firm caused through changes in exchange rates. Deals with the competitive aspect of the firm through changes in exchange rates (Eiteman, Stonehill and Moffett, 2010). •
Translation Exposure – measures the risk associated with changes in owners-equity (assets, liabilities etc), because of the need to translate foreign subsidiary statements into a single currency reporting statement (that of the parent company) for worldwide consolidation of financial statements (Eiteman, Stonehill and Moffett, 2010).
1.2 Hedging Foreign Exchange Exposures
Through hedging MNE’s aim to manage the risk associated with the various types of foreign exchange exposures. Hedging is the acquiring of a position that will rise or fall in value and offset a fall or rise in the value of another position; positions can include the acquiring of assets, cash flows or contracts (Eiteman, Stonehill and Moffett,...
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