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Foreign Exchange Hedging Strategies at General Motors

As GM expanded worldwide, the magnitude of its exposures to foreign exchange grew. Exchange rate swings directly flows into GM s income statement which associates GM to transactional exposure in forex. Treasury team was responsible for all of GM s monetary transactions and all the risk associated with it. Eric Feldstein, Treasurer and Vice-President, Finance at General Motors had to take significant risk management decisions regarding their foreign exchange exposure in Canadian dollar and Argentinean peso. GM had a set of policies with respect to foreign exchange risk management and hedging procedures. But occasional situations required special attention and a possible deviation from the stated policy. Feldstein, who had the authority to sign off on policy deviations, was reviewing such proposals for the Canadian dollar and Argentinean peso.

Canadian Dollar Issue

+ US dollar-denominated flows were so large that the USD was effectively the primary operating currency of the company despite GM Canada s very large Canadian dollar assets and liabilities. + Since GM Canada s functional currency was USD, its exposure to Canadian dollar was recognized as a foreign currency exposure. + Projected Cash flow exposure of GM Canada: -1682 C$ + Net Monetary Asset/Liability exposure of GM Canada: -2143 C$ + GM s policy didn t allow hedging on Net Monetary Asset/Liability exposure. As such, Feldstein need to take a decision on how to reduce this exposure.

Review of Corporate hedging strategy Corporate hedging strategy was establishes to meet three primary objectives: y Reduce cash flow and earnings volatility y Minimize the management time and costs dedicated to global FX management y Align FX management in a manner consistent with how HM operates its automotive business.

Passive Policy: Hedge 50% of commercial Exposures The policy adopted was generally to hedge 505 of all significant foreign exchange commercial exposures on a regional level. The policy differentiated between commercial exposures and financial exposures in the following way: Commercial exposure-> cash flows associated with the ongoing business such as receivables and dividends Financial exposure-> debt payments and dividends are considered as financial exposure.

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Calculation of commercial exposure (operating) Each regional center collected monthly forecasts of accounts receivables and account payable, usually for the twelve coming months. This information was compiled into a matrix presenting the total exposure by currency pair for each regional unit. A determination of riskiness was then made on a regional basis. Deciding which FX exposures were significant enough to warrant hedging. Implied risk=regional notional exposure X annual volatility of relevant currency pair. Net exposure within a region was then hedged to a bench mark ratio of 50%. Commercial exposure (capital expenditure) GM adopted a different approach to hedge capital expenditures because they did not exhibit the same monthto-month volatility or changing forecasts. There were two tests for capital expenditure to be hedged: y The amount should be in excess of $1 million y The implied risk should be equivalent to at least 10% of unit s net worth If investments that met either of the above tests was hedged with forward contracts using a 100% hedge ratio to the anticipated payment date. Financial exposure They were hedged with 100% hedge ratio. Dividends were hedge able only after they were declared, they were hedged using hedge ratio of 50%. Translation exposure (balance sheet) They were not included in GM s hedging policy. Reporting Hedging activities were closely tracked and regularly reviewed within the treasury group. The information was made available to senior management and to the risk management committee to assist in the policy review and creation.

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Solution-1:
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 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

(1,682) (841) 841 (841)

(1,682) (841) 841 (841)

(2,143)

(2,143)

(43.4) 17.0 (26.4) (17.2)

40.8 (16.0) 24.8 16.1

1.5780 (3.1%) 1.5291 75% 3.1% Stronger

1.5780 3.1% 1.6269

3.1% Weaker

-1682 -1261 0 1261 -420

-1682 -1261 0 1261 -420

-2143

-2143

-43.4 25.6 -17.9 -11.6

40.8 -24.0 16.8 10.9

1.578 -0.031 1.529082

1.578 0.031 1.626918

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Argentinean Peso Issue

+ To rampant inflation, the local government exercised control over foreign currency exchange and maintained a peg to the US dollar at ARS 1: USD 1. + With Debt to Equity ratio of 45% and $16.5 billion coming due soon, Zero Deficit law passed by the government has put Argentina at serious risk of defaulting. + Treasury analysts forecast devaluation of ARS against USD from 1:1 to 2:1. + Devaluation has two impacts: - Local currency equivalent of USD borrowing will grow. - Translational loss on GM Argentina s ARS denominated net assets. + USD liabilities of GM Argentina: $325.7 million. + ARS denominated Net Assets: ARS 190 million. + Feldstein needs to take decision on how to minimize forex risk associated with GM Argentina.

ARS Monetary Assets dollars)

(Figures in Million ARS Monetary Liability 45.8 3.2 130.6 2.7 7.8 190.1 129.2 ( Figures in USD Monetary Liabilities 2.5 20.5 23 302.8 Accounts Payable Loans Total 224.5 101.3 325.8 Payables to local suppliers Provisions to local suppliers ARS loan Other Provisions Tax Payable Total 24.1 11.3 13.7 9.8 2 60.9

Scrap incentive owned by Govt. Interest subsidy owned by Govt. VAT credit and other tax Receivable Other Total Net ARS Exposed Assets USD Monetary Assets Million dollars) Cash receivables Total Net USD Exposed Liabilities

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Solution-2: After 1 month:

Net USD Exposed Liabilities Net ARS Exposed Assets After 1 Month Forward Rate Spot Rate No Hedge Net USD Exposed Liabilities Net ARS Exposed Assets Cost of Hedging Total Gain/loss Hedged (50%) Hedged USD Liability Hedged ARS Assets Unhedged USD Liability Unhedged ARS Assets Cost of hedging Total Gain/loss Hedged (75%) Hedged USD Liability Hedged ARS Assets Unhedged USD Liability Unhedged ARS Assets Cost of hedging Total Gain/loss $ $ $ $ $ $ 227.10 96.90 75.70 32.30 6.91 (76.34) $ $ $ $ 216.29 92.29 37.85 16.15 $ $ $ $ (10.81) (4.61) (37.85) (16.15) $ $ $ $ $ $ 151.40 64.60 151.40 64.60 4.61 (122.89) $ $ $ $ 144.19 61.52 75.70 32.30 $ $ $ $ (7.21) (3.08) (75.70) (32.30) Peso 1.05/USD Peso 2/USD Rate (1:1) $ 302.80 $ 129.20 0 $ (216.00) Rate (2:1) $ 151.40 $ 64.60 Net Change $ (151.40) $ (64.60) ARS ARS 302.80 129.20 $ $ 302.80 129.20

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After 6 months:
After 6 Months Forward Rate Spot Rate No Hedge Net USD Exposed Liabilities Net ARS Exposed Assets Cost of Hedging Total Gain/loss Hedged (50%) Hedged USD Liability Hedged ARS Assets Unhedged USD Liability Unhedged ARS Assets Cost of hedging Total Gain/loss Hedged (75%) Hedged USD Liability Hedged ARS Assets Unhedged USD Liability Unhedged ARS Assets Cost of hedging Total Gain/loss $ $ $ $ $ $ 227.10 96.90 75.70 32.30 31.00 (169.00) $ 168.22 $ 71.78 $ 37.85 $ 16.15 $ $ $ $ (58.88) (25.12) (37.85) (16.15) $ $ $ $ $ $ 151.40 64.60 151.40 64.60 20.66 (184.66) $ 112.15 $ 47.85 $ 75.70 $ 32.30 $ $ $ $ (39.25) (16.75) (75.70) (32.30) Peso 1.35/USD Peso 2/USD Rate (1:1) $ 302.80 $ 129.20 0 $ (216.00) Rate (2:1) $ 151.40 $ 64.60 Net Change $ (151.40) $ (64.60)

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After 12 months:
After 12 Months Forward Rate Spot Rate No Hedge Net USD Exposed Liabilities Net ARS Exposed Assets Cost of Hedging Total Gain/loss Hedged (50%) Hedged USD Liability Hedged ARS Assets Unhedged USD Liability Unhedged ARS Assets Cost of hedging Total Gain/loss Hedged (75%) Hedged USD Liability Hedged ARS Assets Unhedged USD Liability Unhedged ARS Assets Cost of hedging Total Gain/loss $ $ $ $ $ $ 227.10 96.90 75.70 32.30 43.52 (205.52) $ 151.40 $ 64.60 $ 37.85 $ 16.15 $ $ $ $ (75.70) (32.30) (37.85) (16.15) $ $ $ $ $ $ 151.40 64.60 151.40 64.60 29.02 (209.02) $ 100.93 $ 43.07 $ 75.70 $ 32.30 $ $ $ $ (50.47) (21.53) (75.70) (32.30) Peso 1.5/USD Peso 2/USD Rate (1:1) $ 302.80 $ 129.20 0 $ (216.00) Rate (2:1) $ 151.40 $ 64.60 Net Change $ (151.40) $ (64.60)