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GM’s Foreign Exchange Hedging Strategy 1
Foreign Exchange Hedging Strategies at General Motors: Transactional and Translational Exposures
Competitive Exposure
GM’s Foreign Exchange Hedging Strategy 2
About General Motors (GM) and its Foreign Exchange Policy
Since the early 1930, General Motors has enjoyed the status of being one of the largest card
manufacturers in the world. As per the financial statements of 2000, GM earned a net profit
of $4.4 billion on sales of $184.6 billion. Though the company enjoyed selling majority of its
production in USA, it is fast getting its foothold in the international market and it has also
reached to the level of 18% of the total sales.
Following are the objectives of the GM’s foreign exchange risk management policy:
a) Reduction in cash flow and earnings volatility
b) To save the valuable management time
c) Reduce the costs directly associated with FX management
As of now, the company has only been managing the cash flow exposure (which is
transaction exposure) and not the balance sheet exposure (which is translation exposure). The
company had adopted the policy of hedging the 50% of all the significant foreign exchange
exposure arising out of receivables and payables. For the exposures arising with in the six
months, the company has adopted to hedge through forward contracts and in respect of the
exposure from seven to twelve months, the company has adopted to hedge the risk through
options.
The overall exposure of GM through forecasted receivables and payables is that of $900
million.
GM’s Competitive Exposure
The major competitors of GM are the Japanese companies like Toyota and Honda which are
fast having their presence felt in the US automobile industry. A larges part of their costs of
manufacturing consists of Yen and any fluctuations in Yen vs. Dollar seriously affect their
GM’s Foreign Exchange Hedging Strategy 3
operating profits. As of year 2000, the Japanese companies can not afford to ignore the US
market as 43% of their earnings comes from US alone. With the appreciation of Japanese
Yen from 117 to 107, the combined global profits of the company were reduced by $4 billion.
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.
Quantification of the Competitive Exposure of GM
Assumptions:
Japanese car makers source 40% content from Japan (worst case scenario).
Japanese carmakers pass on the cost savings to their customers up to 40 – 45% (worst
case scenario).
Devaluation of Yen by 20% in comparison 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 perpetuity at 20% discount rate.
Japanese carmakers General Motors
Cost of Car Price of car
Component cost (of Japanese component) at old exchange rate of $1=100¥ (40% components sourced from Japan)
Component cost at new exchange rate of $1=120¥
Change in profit margin
Addl. Margin passed on to customers ( = 45% of change in profit margin)
$20,000 $25,900
¥800,000 = $8000 ¥800,000 = $6,666.67
$1,333.33
$600.00
GM’s Foreign Exchange Hedging Strategy
New price of car Price decrease
Increased sales (elasticity = 2) Sales in 2000
Increase in sales in 2001 (Gain by Japanese carmakers shared by Big Three)
4
$25,300 2.32% 4.63% 4100000
189962 63321
Income loss for 2001
Income loss for perpetuity (Discounting at 20%)
$249,358,098 $1,246,790,490
Thus there is a loss of $1.24 billion to GM which they can not definitely afford to ignore.
The above calculations do not include the growth in respect of the various variables and the market at large.
Sensitivity Analysis
We have conducted an sensitivity analysis to judge the varying Yen/Dollar exchange
rates. The range is from $1 = 120 Yen to $1 = 80 Yen. Also the content sourced from
Japan has been varied from 20% to 40%. Varying these parameters, we get the values
for income loss/gain for 2001. These values are discounted at 20% to find out the
loss/gain to perpetuity. In this analysis, the margin passed on by Japanese carmakers
has been fixed at 45%.
Exchange Rate: $1= Japanese content 20%
30%
40%
120 ¥
$623,405,090
$935,097,790
$1,246,790,490
100 ¥ 90 ¥
0 $415,596,830
0 $623,405,090
0 $831,193,660
80 ¥
$935,097,790
$1,402,636,840
$1,870,175,890
Another sensitivity analysis has been carried out, wherein the Japanese content in the
automobiles is varied from 20% to 40% and the margin passed on by Japanese carmakers to
customers has been varied from 15% to 45%. Here the exchange rate has been kept constant
at $1 = 120¥
Japanese content
Margin passed on by carmakers to customers 15%
30%
20% Japanese
$207,808,260 $415,596,830
30%
$311,712,390 $623,405,090
40%
$415,596,830 $831,193,660
GM’s Foreign Exchange Hedging Strategy 5
45% $623,405,090 $935,097,790 $1,246,790,490
In the above case, the erosion has ranged from $208 to $1.25 billion
Recommendations:
From the above analysis done, the following course of action (s) can be suggested to GM:
Shifting some of its production to Japan
Source the parts from Japan
The above mentioned suggestions have long term implications and involve lot of other issues
like tax structure, barrier to entry, capital expenditure and the like. The company can not just
take these decisions for just hedging purposes. It is suggested that the management of GM
should thoughtfully and carefully examine all the points.
The current GM policy does not know how to deal with the competitive exposure. One of the
very good suggestions could be that GM can increase its Yen borrowings which would also
act as the natural hedge to any depreciation in the Yen and would also not require the use of
complex derivatives.
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