Group 6: Xi Liu, Shulei Yuan, Cian Shalloe, Kevin McSweeney & Ciara Ronayne
In theory, hedging should help companies protect themselves against unexpected moves in exchange rates.In practice, however, results vary depending on the design, execution and timeliness of hedging strategies.
Didier Cossin and Dinos ConstantinouHedging your bets to protect against riskFt.com (April 6, 2006)
General Motors Passive Hedging Strategy What is hedged?
What? Balance Sheet Exposures resulting from subsidiaries dealing in currencies other than the operating currency of the parent.
How? Rate changes gains or losses in Income Statement adverse/favourable effects on Balance Sheet Assets & Liabilities
Example = Net property owned (Exhibit 3)
GM policy to not hedge, however GM are still mindful of exposures
Make sure you can explain the Net Property Owned chart and tie it back to the point.3
General Motors Passive Hedging Strategy
Maybe see if this can be formatted to show data labels more clearly. Excellent chart though.4
General Motors Passive Hedging Strategy What was hedged? Transactional Exposures
What? Exposures affecting cash flows e.g. receivables & payables.
How? Agreements entered into before rate change & settled after change.
GM exposed to almost every major currency through its regional divisions Exhibit 6
General Motors Passive Hedging Strategy What was hedged?
General Motors Passive Hedging Strategy What was hedged? Economic Exposures
What? Sensitivity to rate changes where effects longer lasting
How? Currency devaluation/appreciation
Effects may be greater than translation/transaction as will affect overall supply & demand
Is this slide relevant? I cant see much about how GM hedge these types of exposures proactively. If you want to include this, make sure you can answer questions on it.7
General Motors Passive Hedging Strategy How much was hedged? Commercial (Operating) exposures
Regions forecast net receivables/payables position for 12 months against each currency
Implied Risk = Notional Exposure x Annual Volatility of Pair
50% Hedge where Implied Risk > $10m
Reduced to $5m for particularly volatile currency pairs
General Motors Passive Hedging Strategy How much was hedged?
Commercial (Capital Expenditure) Exposures >$1m = 100% hedged
Financial exposures (loan repayments, etc.) are judged on a case by case basis
Translation exposures are not hedged
General Motors Passive Hedging Strategy Where were decisions made? High level:
Treasurers Office & Risk Committee
Set benchmarks, instrument selection & set processes
Domestic Finance Group (NA, LA & AME)
European Regional Treasury Centre (Europe & Asia Pacific)
Split to match geographical footprint but still benefit from pooling resources
Ciara, does this look better? Im not sure if this is what you were going for.10
General Motors Passive Hedging Strategy Deviations from policy
Deviations from set policy possible required scrutiny & sign off from senior executives
Translation exposures large enough to warrant hedging?
Potential to increase hedging for commercial operating exposures from 50% up to 75%
What type of hedging instruments are appropriate for GM?
Forward ContractA Forward contract is an agreement to buy or sell an asset in the future at a certain price agreed upon today. Forwards are suitable for GM as :
Many overseas customers and suppliers a lot of foreign currency exposuresEffective for short term hedges tailored to GMs needsA wide range of operations all over the world urgent need to hedge currency risks (e.g. Canadian Dollar and Argentinean Peso)
What type of hedging instruments are appropriate for GM?Future ContractThese contracts are similar to forwards, but futures are more generic and are tradable in a market, with relatively lower transaction costs . This is not appropriate for GM as:
A number of geopolitical risks prefer more flexible and specific hedging instrumentsThe standardised nature of Futures hinder GMs ability to hedge with precision.Suitable for a smaller company (financial difficulty/a limited number of currencies)
What type of hedging instruments are appropriate for GM?Option ContractThis type of contract gives the holder the right, but not the obligation, to buy (call) or sell (put) a given quantity of an asset in the future, at prices agreed upon today. This type of Instrument is suitable for GM as :
GM can choose whether to buy: -A tailor-made currency option specific needs, more expensive. -A standard option exercise the option at any point/sell the optionA great deal of uncertainty about future spot rates foreign currency receipts and payments more flexibility around long term hedging strategies.
What type of hedging instruments are appropriate for GM?Swap ContractThis is a formal agreement whereby two organisations contractually agree to exchange payments on different terms. This can possibly be another appropriate instrument for GM to use as:
Can provide hedging for longer periods than the forward marketEasy to arrange and flexible Transaction costs are low (only legal fees, no commission or premium)Obtain the currency they require , with avoiding uncertainties Unfortunately, a high degree of counterparty risk can be present
Should the same instruments be used in all situations?
Not all of these strategies are suitable to use for the same situation
Factors that need to be considered for choosing a suitable hedging strategy include :The cost of implementing a hedge, The degree of flexibilityThe duration of the hedge
Different strategies are suitable for different conditions (Prudence)
Do we need both natural hedging slides? One may be enough18
Foreign Exchange Committee manages exchange rate risk
80% exposure hedged
Mixture of forwards & options
Assessment of market conditions.
92/93 38% drop in sales
Aggressive hedging strategy
100% exposure hedged
Rolling put options
GMs Exposure to the Canadian Dollar
What is the extent of GMs exposure to the CAD?
C$1.682bn negative cash flow exposure resulting from Canadian Operations
C$2.143bn net liability exposure on GM-Canadas Balance Sheet
GM are concerned that the CAD will appreciate
How much is at risk?Using the Implied Risk Function;Implied Risk = Regional Notional Exposure x Annual Volatility of Relevant Currency Pair
Annual Intraday USD/CAD Volatility of 0.53% for 2001CAD$1.682bn x 0.53% Annual Average Intraday Volatility for 2001 = C$89,146,000
Low volatility due to high interdependence between USA and Canada
GM feels that a higher amount than this needed to be hedged
What Hedging Instruments are available to GM in this case?Forwards and Options currently usedForwards for short term hedgingOptions for longer term hedging
Cost differences and volatility are major factors
Forwards and Options give more flexibility than Futures
Potential EPS Impact of Loonie Fluctuation
Here, we can see the impact a 3.1% fluctuation in the Loonie Rate will have on our C$1.682bn Cash Flow ExposureHere, we can see the impact a 3.1% Fluctuation in the Loonie Rate has on our C$2.143bn Net Liability Position
How much should be hedged?
External Factors must be considered
Reduced Earnings Volatility a goal of Treasury Department
75% Hedging Strategy compliments this goal
Prudent in the face of increased macroeconomic risks
What should GM do?Options create more value than Forwards if a depreciation occurs
Forwards create more value than Options if appreciation occurs
75% Hedge Strategy reduces volatility
In Reality, a mixture of both may be best course of action
Close analysis of factors surrounding rate fluctuations is essential
Our USD costs are less if we hold a forward contract when rate appreciates, and similarly, Options create more of a cost saving when rates depreciate, as can be seen in the 50% Hedged Strategy line graph to the left.
The same logic applies to the 75% Hedged Strategy. For a 75% Hedge, we are hedging more risk so our cost volatilities are less than a 50% Hedge.