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