The BMW Group

Introduction

Bayerische Motoren Werke GmbH came into being in 1917, having been founded in 1916 as
Bayerische Flugzeugwerke AG (BFW); it became Bayerische Motoren Werke Aktiengesellschaft
(BMW AG) in 1918. As of 2009, the BMW Group covered the BMW, MINI and Roll-Royce
brands, being present in the world markets with 24 production and assembly plants, 43 sales
subsidiaries and a research and development network. Activities are carried out through three
business segments: Automobiles, Financial Services and Motorcycles. Despite the financial
crisis, the Group achieved positive group earnings for the 2009 financial year, thanks to their
crisis management and innovative projects. More than 1.28 million customers purchased a BMW,
MINI or Rolls-Royce during 2009, and over 87,000 customers bought a BMW motorcycle. Of
the 2009 Group revenue, 77% was derived from outside Germany; specifically, rest of Europe
25%, North America 23%, Asia/Oceania 17%, United Kingdom 8%, and other markets 4% (1).

Risks of Currency Fluctuations

Multinational enterprises, such as BMW, are heavily affected by macroeconomic conditions.

International economic crisis and its impact - such as changes on international raw materials
markets and currency exchange rates - on financial, goods and services markets have significant
impact on revenues and earnings of MNEs. To eliminate such risks, financial investors and
businesses use hedging instruments. There are three basic ways to manage currency risks. The
first approach is not to hedge at all, assuming that currency fluctuations will wash out over a
period of time; the second approach is to hedge fully, which may reduce the volatility of the
portfolio. The third approach is to actively manage hedging, choosing when and how much to
hedge. In short, hedging can be described as an insurance policy that limits the impact of foreign
exchange (FX) risk.

Risk management

The monetary flows between an MNE’s entities constitute FX risks whenever currencies
appreciate or depreciate against each other. To tackle these issues BMW manages its own
treasury centers in different regions – all reporting to a central office in Munich (1). These
treasury centers plan and execute foreign exchange hedging strategies, derived from BMW’s own
model for currency valuation (2). BMWs hedging focus is long-term, with a scope up to 6 years.

As BMWs cars are exported globally - incomes are generated in various currencies. Each unit
sold is later measured in it's "original currency" (where it was produced), which introduces the
risk of translation exposure. To give an actual example; With rising sales in the US market, the
amount of cars sold in the US market is currently higher than the amount of locally produced
cars. The majority of BMW cars sold are therefore imported in order to satisfy the high US
demand. When an european car is sold in the US, the translation value of $ against € could either
mean a gain or a loss for BMW.

To tackle this translation exposure risk, BMW assumes a strategy called natural hedging -
meaning that operating revenues and operating expenses should remain in the same currency -
meaning that cars sold in € countries should also be produced in € countries. This way the
transaction between manufacturer and customer doesn't undergo any currency exchanges.
Satisfying the US demand by increasing the production at the US plant would therefore hedge the
translation exposure risk - because the cars aren't imported anymore. Natural hedging has been
employed by BMW since 2008. (3, 4).

Currency hedging

Currency hedging is essentially a way to minimize and control the risk - e.g. commodity price
changes, inflation, currency exchange rate prices etc - that is involved in any form of foreign
investment. The process of currency hedging attempts to compensate for any changes in relative
value of the specific currency being utilized in the investment scheme. In very simple terms,
currency hedging is the act of entering into a financial contract in order to protect against
unexpected, expected or anticipated changes in currency exchange rates. The way currency
hedging works is that the investor converts or exchanges foreign currency at a time when the
exchange rate is particularly favorable. Then, they would make the actual investment with
currency that is native to the country in which the investment is based.

Companies use derivative instruments, especially hedge instruments to protect the company from
future risk. Instruments such as options, forward and future contracts are used by BMW in order
to diversify the risk. If, for example, BMW wants to decrease their exposure to US Dollar
fluctuations, they can easily engage in a forward contract that specifies that BMW will buy a
fixed amount of US Dollars for a specified price (in another currency) at a specified date. By
entering into such a contract, BMW is fully protected against currency fluctuations within the
volume of the contract. Of course there is a wider variety of instruments on the market but we
decided to only focus on forward contracts in the above example. In conclusion a forward
contract can be summarized as a measure to give away potential gains while limiting potential
losses at the same time.

Companies use hedging strategies to manage the risk not only on their existing accounts and
contracts but also on expected future cash flows. This is what BMW is doing in their foreign
business in the United States. BMW has also been buying forward contracts and options with
three-year maturities. The strategy to buy forward contracts is to hedge future losses by giving
up future gains – thus “buying time” and not gambling with fluctuation. Forward contracts are the
most common hedging strategies.

Another strategy, foreign currency exchange hedging is used more effectively. By purchasing
one option by the money received on the option sold at out of the money, BMW can cover risk
exposed between the strike prices. When US dollar weakens, the company can exercise sold
options and when US dollar strenghtens, the company can exercise bought options. Also BMW
pursues a “cascade strategy” to cover the risk in the future year by year. For example, in 2005 it
would be difficult to expect how the exchange rate will be in 2007 to secure 100% of US dollar
volumes. Therefore, by stepping up the coverage over the years, in 2005 33%, in 2006 33% to
42% and in 2007 rest of the amount would be hedged.

Although currency hedging may seem to be a complex and intense practice - it makes a
difference on a large scale. With regard to the millions of dollars worth of cars exported by BMW
annually - the slightest change in foreign exchange rates make a significant impact on their
earnings.

Questions:

1. As we pointed out, hedging is important for any MNC that engages in international import and
export activities. With the growing importance of emerging markets like China, India or Brazil
(8), would you recommend that BMW should also consider hedging in those markets/currencies?

2. Do you believe that natural hedging, as mentioned above, is valid solution for a car
manufacturer such as BMW? What might be advantages/disadvantages of this hedging solution?

BMW.com 1 -
http://www.bmwgroup.com/annualreport2007/nav/index.html?http://www.bmwgroup.com/annu
alreport2007/zahlen_und_fakten_2007/risikomanagement.html

http://www.bmwgroup.com/annualreport2009/nav/index.html?http://www.bmwgroup.com/annua
lreport2009/start.html

2 - http://www.worldcarfans.com/1080619921/bmw-group-to-invest-a-billion-us-dollars-in-the-
usa-by-2012

3 - http://news.bbc.co.uk/2/hi/business/7302540.stm

4-
http://www.bmwgroup.com/e/nav/index.html?http://www.bmwgroup.com/e/0_0_www_bmwgro
up_com/investor_relations/corporate_news/news/2008/Umsatzmeldung_01_2008.html

5 - Details provided by BMW Group in personal communication

6. http://currencyhedging,org

7. http://www.investorguide.com/igu-article-282-forex-basics-the-basics-of-currency-
fluctuations.html

8. http://www.ft.com/cms/s/0/8085ac22-6756-11df-a932-00144feab49a.html