Question

Describe the hedging policy implemented by GM? 2. What do you think of GM's foreign exchange hedging polices? Would you advise any changes?

refer to case study of Foreign Exchange Hedging Strategies at General Motors

Answer 1

Based on the parameters of the company and the key objectives of the company risk management policy, the appropriateness of the GM’s corporate hedging policy can be analyzed. Generally, corporate hedging serves the purpose of maximizing value through risk management. However, GM has its own specific objectives such as to decrease the volatility of the cash flows and earnings along with the limited time and cost allocation to this particular strategy. Therefore, in order to serve the purpose the company adopted passive hedging policy to manage foreign exchange risk, regionally. Based on the fact that, 72% of the GM’s sales were regional i.e. in North America; therefore, managing risk regionally to assure consistency with the company operations seems sensible. Moreover, the company has not yet experienced any significant exposure to yen from any foreign exchange transaction; therefore, it is wiser to adopt the passive strategy. This argument is further validated by the results of an internal study that the active management of the foreign exchange exposure does not outperform the passive management of risk. Besides, the 50% of the foreign exchange exposure is hedged, which seems appropriate as the company has not experienced any substantial exposure yet and even if the market does not behave in favor of GM 50% is still hedged, and if it operates in favor of the company; not only GM will enjoy the benefits but also it will be able to save those funds which could have been used for the rest of the 50% FX exposure.

General Motors’ current policy for managing foreign exchange hedging is that it only opts to hedge its exposure of transaction risk and only 50% of the transaction risk is headed which is prioritized on the basis of higher volume of transactions, but this is not good policy for hedging it will leave the balance 50% of transaction un-hedged exposing the GM with a transactional exposure of foreign exchange risk. Meanwhile GM’s hedging policy is that they do not hedge the translation exposure, which is another deficiency of policy because if they do not hedge their translation risk it could also badly impact the financial results of GM in any financial period. In addition to this the exposure is being managed at regional basis rather than worldwide, centrally managed policy of hedging the foreign exchange risk.

However, the current policy is not a perfect policy because they are leaving their firm exposed to the 50% of transactional exposure risk, meanwhile, this policy should be changed to hedge 100% of transactional exposure and the criterion that only higher value transactions are hedge is another lacking point because the decision to hedge should be based on the volatility of foreign currency involved and if there are more transactions in highly volatile foreign currency than this should be hedge in order to avoid the exchange rate risk. Additionally, the translation risk is not being hedged but this will also impact their financial statement, therefore, this risk should be hedged by using a matching concept which is that GM should try to create foreign liabilities to match with the foreign assets or vice versa. In this way they will be able to avoid the translation exposure without spending money on hedging instruments. At last but most important problem with GM’s hedging policy is that they are managing the hedging on regional basis would better be able to manage on a centralized basis because these enable GM to match the payment and receipt of much of their foreign currencies in internal reconciliation of inflow and outflow of foreign currency and the balancing foreign currency amount should be hedged at central level.