Foreign Exchange Hedging Strategy at General Motors Transactional and Translational Exposures
Foreign Exchange Hedging Strategies at General Motors: Transactional and Translational Exposure
Problem Statement
In September of 2001 General Motors (GM) was faced with a billion dollar exposure to the Canadian dollar. At the time, North America represented approximately three-quarters of GM’s total sales and this large exposure to the CAD could significantly affect GM’s financial results. GM had a passive strategy of hedging 50% of its exposure; this paper explores the impact of hedging 75% of the exposure.
Additionally, GM faced a unique problem in Argentina, which was at risk of defaulting on its international loans. A default would also cause the Argentine Peso to be devalued from 1 peso to 1 dollar to 2 pesos to 1 dollar, a substantial change. The chance of the default was estimated to be 40 to 50%. While the exposure was smaller than Canada, it was still significant at $300 million.
Background
GM has had foreign currency exposure risks for decades. These foreign currency exposures are related to buying, selling, and financing in currencies other than the local currencies in which they operate. Derivative instruments, such as foreign currency forwards, swaps and options are used primarily to hedge their exposures with respect to forecasted revenues, costs and commitments noted in foreign currencies (Wagoner, pg 134). These contracts generally mature in approximately 32 months. As of December 2008, GMs three most significant foreign currency exposures were the U.S. Dollar/Korean Won, Euro/British Pound and U.S. Dollar/Canadian Dollar (Wagoner,134).
GM is also exposed to foreign currency risk in other ways; namely, as they convert the results of the international operations into U.S. dollars as part of their consolidation process. Variation in exchange rates can consequently create instability in the results of GM operations and may unfavorably affect their financial position. For example, the effect of exchange rate
Problem Statement
In September of 2001 General Motors (GM) was faced with a billion dollar exposure to the Canadian dollar. At the time, North America represented approximately three-quarters of GM’s total sales and this large exposure to the CAD could significantly affect GM’s financial results. GM had a passive strategy of hedging 50% of its exposure; this paper explores the impact of hedging 75% of the exposure.
Additionally, GM faced a unique problem in Argentina, which was at risk of defaulting on its international loans. A default would also cause the Argentine Peso to be devalued from 1 peso to 1 dollar to 2 pesos to 1 dollar, a substantial change. The chance of the default was estimated to be 40 to 50%. While the exposure was smaller than Canada, it was still significant at $300 million.
Background
GM has had foreign currency exposure risks for decades. These foreign currency exposures are related to buying, selling, and financing in currencies other than the local currencies in which they operate. Derivative instruments, such as foreign currency forwards, swaps and options are used primarily to hedge their exposures with respect to forecasted revenues, costs and commitments noted in foreign currencies (Wagoner, pg 134). These contracts generally mature in approximately 32 months. As of December 2008, GMs three most significant foreign currency exposures were the U.S. Dollar/Korean Won, Euro/British Pound and U.S. Dollar/Canadian Dollar (Wagoner,134).
GM is also exposed to foreign currency risk in other ways; namely, as they convert the results of the international operations into U.S. dollars as part of their consolidation process. Variation in exchange rates can consequently create instability in the results of GM operations and may unfavorably affect their financial position. For example, the effect of exchange rate