Description
Foreign Exchange Hedging Strategies at General Motors
Foreign Exchange Hedging Strategies at General Motors
Case Study Solution
Agenda
1.
2.
3.
4.
5. 6.
What kinds of risks do FX pose for multinationals? How should a MNC design a risk management policy for FX? How would you evaluate GM’s hedging policy? Why is the CAD exposure so troubling? How do you trade off options and forwards? How is GM exposed to the yen?
2
Why do companies hedge?
? To reduce transaction costs. ? Since individual investors can hedge on their own, why should a firm do so? ? A firm can likely hedge more efficiently than an individual investor ? To provide for future investment needs ? To manage earnings ? To speculate ? To make evaluating a company’s operations
easier ? To make the comparison of the foreign subsidiary operations easier
3
What risks do multinationals face from FX? 1. Transactional exposures
•
•
Arise from real transactions such as debt and A/R Affect income statement
2. Translational exposures • Not economic one • Affect balance sheet 3. Operational exposures • Real and economic • Indirectly arise from competitive interactions 4
What questions must an FX hedging policy of GM address?
What to hedge? Transactional exposures only and only those with an “implied risk” over $10 million (over $5 million for especially volatile currencies) How much to hedge? 50% ration; “passive” How to hedge? Where to hedge? Forwards (0-6) and options (6-12) Regionally
When to deviate? Try to stay “passive”; hedging decisions that do not follow the policy require approval What is the difference between active and passive hedging?
5
Shapiro: Unknown cash flow should use option
FX exposures to GM
1. 2.
CAD
Transactional and translational exposures
Argentina peso
How to deal with the widely-anticipated evaluation of the peso
3.
Yen
Operating exposure
6
GM’s Policy on how much to hedge
? GM forecasts operating exposures for all its
regions on a monthly basis. ? The “riskiness” of these exposures = net(regional) exposure * annual volatility of the currency pair (%) ? If the result > $10 million, GM hedges 50% of the exposure.
7
How much to hedge?
? GM’s North American region had a forecast euro
exposure of $400 million, and the annual volatility of the U.S. dollar –euro exchange was 12% ? The implied riskiness of the exposure was $48 million. ? GM hedged $200 million of its euro exposure
8
Should GM hedge the amount “at risk,” of $48 million or $200 million (50% of the total euro exposure)?
? 48 million “implied risk” is calculated simply to
determine if GM should hedge. ? We hedge the “underlying” risk.
9
How much to hedge?
? The value of our car is $30,000 and there is a 5%
probability of accident ? The expected outcome of accident is losing $1,500 ? How much will you buy the insurance? ? We will buy the insurance for the full value of the car, or $30,000, not $1,500.
10
Should GM hedge on a worldwide or regional basis?
? Pro: GM operates in so many countries, so the
exposures of different subsidiaries would often cancel out ? Save costs ? Con: GM’s subsidiaries have their own objectives.
11
deviations from its hedging policy?
? GM used to actively manage its myriad currency
risks. ? “Active” FX management demands considerable manpower and management attention. ? GM did not consider that active management provided significantly better results.
12
Does GM’s policy on how much to hedge make sense? Why not 40% or 100%?
? Hedge 50% of FX exposures - “safe” ? The mid-point ? a prudent choice ? Easy to explain to shareholders ? Maybe a legal reason ? Expensive to hedge 100%
13
Canadian Dollar Exposure
? GM is short about CAD 1.7 billion ? It has to pay Canadian suppliers for materials and
services.
? A transactional exposure. ? According to GM’s hedging policy, 50% of this
exposure should be hedged.
14
Why did managers request to hedge 75% of thisGM Canada’s balance exposure? ? The concern is that
sheet includes significant pension obligations. ? A total balance sheet exposure is CAD 2.1 billion ? GM’s hedging policy excludes hedging such translational exposure. ? In effect, the translational exposure would be hedged by increasing the hedge on the transactional exposure.
15
How big a difference is this to GM?
HEDGE RATIO SCENARIO - CAD is: Commercial exposure 12-month rolling net receivables forecast (CAD) Notional hedge amount at hedge ratio (CAD) Net cash (CAD) FX hedge put in place (CAD) Net FX exposure (CAD) GM Worldwide US GAPP FX exposure GM Worldwide US GAPP FX exposure (CAD) Earnings impact on GM Worldwide GM Worldwide FX gain/(loss) FX gain/(loss) on hedges GM Worldwide pre-tax income impact GM Worldwide after-tax (35%) income impact Scenario CAD/USD FX rate Range CAD/USD FX rate - sensitivity 50.0% 3.1% Stronger 3.1% Weaker 75.0% 3.1% Stronger 3.1% Weaker
(1,682) (841) 841 (841)
(1,682) (841) 841 (841)
(1,682) (1,261) 1,261 (420)
(1,682) (1,261) 1,261 (420)
(2,143)
(2,143)
(2,143)
(2,143)
(43.4) 17.0 (26.4) (17.2)
40.8 (16.0) 24.8 16.1
(43.4) 25.6 (17.9) (11.6)
40.8 (24.0) 16.8 10.9
1.5780 (3.1%) 1.5291
1.5780 3.1% 1.6269
1.5780 (3.1%) 1.5291
1.5780 3.1% 1.6269
16
Why is the CAD exposure so problematic?
•Transactional – Short CAD 1.7bn
•Translational – Short CAD 2.1bn •What are they doing?
–
Hedging a translational exposure through increased “transactional” hedges…
•How should GM use forward and options to hedge?
17
How can forwards and options be compared for hedging the CAD?
2,000,000 Exp + Fwd 1,500,000 Exp + Opt Exposure 1,000,000
500,000
-
(500,000)
(1,000,000)
(1,500,000)
18
(2,000,000) 1.4000
1.4500
1.5000
1.5500
1.6000
1.6500
1.7000
1.7500
1.8000
What about the ARS exposure? What can you do about that now?
What are the forward rates telling you?
What does this mean for how expensive hedging is by this time?
19
How and why is the yen a competitive exposure?
Tracing the chain through all the way from a yen devaluation to GM PV consequences…
20
But how does the yen exposure fit in with other yen exposures?
These exposures must be combined relative to other exposures…
21
What else can GM do about the yen exposure?
1. Lower its own US prices domestically • To combat some loss in market share 2. Change sourcing • Get same benefits as Japanese automakers – buy plants in Japan 3. Borrow yen and use yen to finance its lower price
strategy
•
Might be easier than buying a Japanese plant
4. Increase investments in Japanese companies
22
What other companies would you expect competitive exposures to be big in?
? Boeing & Airbus; Harley-Davidson Steel
? How could we analyze GM’s competitive
exposure to the yen more rigorously?
? Monthly returns of GM = a + (0.987 *S&P500
returns)
? GM moves in line with market
? Monthly returns of GM = a + 0.4 (returns of $/yen) ? When we see 10% devaluation in USD, GM stock return increase 4%.
23
Source: Rohan Williamson, 2001, “Exchange rate exposure and competition: evidence from the automative industry,” Journal of Financial Economics 59, 453-475
24
Source: Rohan Williamson, 2001, “Exchange rate exposure and competition: evidence from the automative industry,” Journal of Financial Economics 59, 453-475
25
Source: Rohan Williamson, 2001, “Exchange rate exposure and competition: evidence from the automative industry,” Journal of Financial Economics 59, 453-475
26
Why has yen become more important?
? Closer integration of product market
27
doc_722752067.pptx
Foreign Exchange Hedging Strategies at General Motors
Foreign Exchange Hedging Strategies at General Motors
Case Study Solution
Agenda
1.
2.
3.
4.
5. 6.
What kinds of risks do FX pose for multinationals? How should a MNC design a risk management policy for FX? How would you evaluate GM’s hedging policy? Why is the CAD exposure so troubling? How do you trade off options and forwards? How is GM exposed to the yen?
2
Why do companies hedge?
? To reduce transaction costs. ? Since individual investors can hedge on their own, why should a firm do so? ? A firm can likely hedge more efficiently than an individual investor ? To provide for future investment needs ? To manage earnings ? To speculate ? To make evaluating a company’s operations
easier ? To make the comparison of the foreign subsidiary operations easier
3
What risks do multinationals face from FX? 1. Transactional exposures
•
•
Arise from real transactions such as debt and A/R Affect income statement
2. Translational exposures • Not economic one • Affect balance sheet 3. Operational exposures • Real and economic • Indirectly arise from competitive interactions 4
What questions must an FX hedging policy of GM address?
What to hedge? Transactional exposures only and only those with an “implied risk” over $10 million (over $5 million for especially volatile currencies) How much to hedge? 50% ration; “passive” How to hedge? Where to hedge? Forwards (0-6) and options (6-12) Regionally
When to deviate? Try to stay “passive”; hedging decisions that do not follow the policy require approval What is the difference between active and passive hedging?
5
Shapiro: Unknown cash flow should use option
FX exposures to GM
1. 2.
CAD
Transactional and translational exposures
Argentina peso
How to deal with the widely-anticipated evaluation of the peso
3.
Yen
Operating exposure
6
GM’s Policy on how much to hedge
? GM forecasts operating exposures for all its
regions on a monthly basis. ? The “riskiness” of these exposures = net(regional) exposure * annual volatility of the currency pair (%) ? If the result > $10 million, GM hedges 50% of the exposure.
7
How much to hedge?
? GM’s North American region had a forecast euro
exposure of $400 million, and the annual volatility of the U.S. dollar –euro exchange was 12% ? The implied riskiness of the exposure was $48 million. ? GM hedged $200 million of its euro exposure
8
Should GM hedge the amount “at risk,” of $48 million or $200 million (50% of the total euro exposure)?
? 48 million “implied risk” is calculated simply to
determine if GM should hedge. ? We hedge the “underlying” risk.
9
How much to hedge?
? The value of our car is $30,000 and there is a 5%
probability of accident ? The expected outcome of accident is losing $1,500 ? How much will you buy the insurance? ? We will buy the insurance for the full value of the car, or $30,000, not $1,500.
10
Should GM hedge on a worldwide or regional basis?
? Pro: GM operates in so many countries, so the
exposures of different subsidiaries would often cancel out ? Save costs ? Con: GM’s subsidiaries have their own objectives.
11
deviations from its hedging policy?
? GM used to actively manage its myriad currency
risks. ? “Active” FX management demands considerable manpower and management attention. ? GM did not consider that active management provided significantly better results.
12
Does GM’s policy on how much to hedge make sense? Why not 40% or 100%?
? Hedge 50% of FX exposures - “safe” ? The mid-point ? a prudent choice ? Easy to explain to shareholders ? Maybe a legal reason ? Expensive to hedge 100%
13
Canadian Dollar Exposure
? GM is short about CAD 1.7 billion ? It has to pay Canadian suppliers for materials and
services.
? A transactional exposure. ? According to GM’s hedging policy, 50% of this
exposure should be hedged.
14
Why did managers request to hedge 75% of thisGM Canada’s balance exposure? ? The concern is that
sheet includes significant pension obligations. ? A total balance sheet exposure is CAD 2.1 billion ? GM’s hedging policy excludes hedging such translational exposure. ? In effect, the translational exposure would be hedged by increasing the hedge on the transactional exposure.
15
How big a difference is this to GM?
HEDGE RATIO SCENARIO - CAD is: Commercial exposure 12-month rolling net receivables forecast (CAD) Notional hedge amount at hedge ratio (CAD) Net cash (CAD) FX hedge put in place (CAD) Net FX exposure (CAD) GM Worldwide US GAPP FX exposure GM Worldwide US GAPP FX exposure (CAD) Earnings impact on GM Worldwide GM Worldwide FX gain/(loss) FX gain/(loss) on hedges GM Worldwide pre-tax income impact GM Worldwide after-tax (35%) income impact Scenario CAD/USD FX rate Range CAD/USD FX rate - sensitivity 50.0% 3.1% Stronger 3.1% Weaker 75.0% 3.1% Stronger 3.1% Weaker
(1,682) (841) 841 (841)
(1,682) (841) 841 (841)
(1,682) (1,261) 1,261 (420)
(1,682) (1,261) 1,261 (420)
(2,143)
(2,143)
(2,143)
(2,143)
(43.4) 17.0 (26.4) (17.2)
40.8 (16.0) 24.8 16.1
(43.4) 25.6 (17.9) (11.6)
40.8 (24.0) 16.8 10.9
1.5780 (3.1%) 1.5291
1.5780 3.1% 1.6269
1.5780 (3.1%) 1.5291
1.5780 3.1% 1.6269
16
Why is the CAD exposure so problematic?
•Transactional – Short CAD 1.7bn
•Translational – Short CAD 2.1bn •What are they doing?
–
Hedging a translational exposure through increased “transactional” hedges…
•How should GM use forward and options to hedge?
17
How can forwards and options be compared for hedging the CAD?
2,000,000 Exp + Fwd 1,500,000 Exp + Opt Exposure 1,000,000
500,000
-
(500,000)
(1,000,000)
(1,500,000)
18
(2,000,000) 1.4000
1.4500
1.5000
1.5500
1.6000
1.6500
1.7000
1.7500
1.8000
What about the ARS exposure? What can you do about that now?
What are the forward rates telling you?
What does this mean for how expensive hedging is by this time?
19
How and why is the yen a competitive exposure?
Tracing the chain through all the way from a yen devaluation to GM PV consequences…
20
But how does the yen exposure fit in with other yen exposures?
These exposures must be combined relative to other exposures…
21
What else can GM do about the yen exposure?
1. Lower its own US prices domestically • To combat some loss in market share 2. Change sourcing • Get same benefits as Japanese automakers – buy plants in Japan 3. Borrow yen and use yen to finance its lower price
strategy
•
Might be easier than buying a Japanese plant
4. Increase investments in Japanese companies
22
What other companies would you expect competitive exposures to be big in?
? Boeing & Airbus; Harley-Davidson Steel
? How could we analyze GM’s competitive
exposure to the yen more rigorously?
? Monthly returns of GM = a + (0.987 *S&P500
returns)
? GM moves in line with market
? Monthly returns of GM = a + 0.4 (returns of $/yen) ? When we see 10% devaluation in USD, GM stock return increase 4%.
23
Source: Rohan Williamson, 2001, “Exchange rate exposure and competition: evidence from the automative industry,” Journal of Financial Economics 59, 453-475
24
Source: Rohan Williamson, 2001, “Exchange rate exposure and competition: evidence from the automative industry,” Journal of Financial Economics 59, 453-475
25
Source: Rohan Williamson, 2001, “Exchange rate exposure and competition: evidence from the automative industry,” Journal of Financial Economics 59, 453-475
26
Why has yen become more important?
? Closer integration of product market
27
doc_722752067.pptx