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Corporate Risk Management MM6021

Individual Assignment
Lecture
By

: Ir. Achmad Herlanto Anggono, MBA


: Nabillah 29114786- YP51

Foreign Exchange Hedging Strategies


at General Motors
Transactional, Translation, and Competitive Exposure

Executive Summary

This report is about foreign exchange risk exposure in General


Motors. Three exposures are explained detailed. The forming of
GM ERM is based on the COSO Framework GM faces significant
level of currency risk due to geographical representation in a
number of countries. GM can broaden the scope of hedge-able
exposures with assessing the consequences carefully. By utilizing
a foreign exchange hedge properly can help to minimize the
amount of risk they take on.

Company Objective

GMs strategic objective to expand around the


world, especially increase market share in Asia.
Figure beside show GMs international operations
was growing as a percent of the overall business.
The company had manufacturing operations in
more than 30 countries, and its vehicles were
sold in approximately 200 countries.

Overview of General Motors


GM was founded in 1908

The worlds sales leader since 1931


The worlds largest automaker in 2001

Operations in more than 30 countries


15.1% worldwide market share in 2001

Product line : Financial Service, Satellite Television and Commercial


Satellite, and Locomotive and heavy duty transmissions

Introduction
General Motors has to manage alternative
responses to these exposures by analyzing
specific hedging decisions and alternatives
Transactional
Exposure

Competitive
Exposure

Translational
Exposure

GM Risk Management Decisions

GMs exposure
to Canadian
dollar with
adverse
accounting
consequences

CAD

GMs exposure
to the
Argentinean
peso when
devaluation is
widely
anticipated

ARS

GMs exposure
to the Japan
Yen are
depreciating
widely
acknowledged

JPY

The Enterprise Risk Management Framework

Internal Environment

GMs international operations was growing as a percent of the overall business

Internal Environment

ERM Philosophy
As GM expanded around the world, the magnitude of its exposure to foreign currencies grew.
Exchange rate swings through GMs reported income statement.

Risk Appetite
GM is exposed to financial risk as it strives to achieve the company objectives.
GMs financial risk appetite is a high that appropriate to expand around the world.

Board Oversight

Risk Management Committee, which was composed of six of GMs most senior executive (CFO,
General Auditor, CAO, Chief Economist, Senior Executive GMAC,GMs Financial Service
Subsidiary).

Commitment to Ethical Value


GM senior executive had implemented a number of formal policies with respect to foreign
exchange risk management and hedging procedures.

Competence and Development of People


The GM Treasury program invested heavily in its people, rotating them through functional
positions and offices around the world, developing their skills and experience.

Assignment of Authority and Responsibility

Treasury team is responsible for all of GMs monetary transactions and for managing the
myriad risks.

Objective Setting
Strategic
External

Expanded around the world, especially increasing market share


in Asia

Operations Executing hedging policies in a cost efficient manner

Reporting

RM Committee met quarterly to review the performance of


GMs financial risk management strategies and to set treasury
policy for GM and its subsidiary

Internal

GM traded on NYSE and was a component of DJIA, so GM


Compliance use GAAP as standard framework of guidelines for financial
reporting

Objective Setting- Operation Goals


Operation goals in hedging policies make GM has to
manage the exposure to :
Reduce

the amount of earnings and cash flow


volatility
Minimize the management time and costs dedicated
to global Foreign Exchange management
Align Foreign Exchange management in a manner
consistent with how GM operates its automotive
business

Event Identification

Financial Risk

General
Market Risk

Foreign
Exchange Risk

Translation
Exposure
Transaction
Exposure
Economic
Exposure

The exchange rate swings created gains or losses that flowed through GMs
reported income statement Foreign Exchange Risk

Event Identification (cont)


Type of risk

Explanation
Canadian
Dollar

GM Canada USD denominted flow but Asset and


Liabilities from CAD.
Impact when the CAD appreciates, EPS declines
and when the CAD depreciates, EPS rises

Transaction
Exposure

Argentina
Peso

A potential devaluation of the peso against the


dollar from 1:1 to 2:1.
Impact gain or lose from consolidating foreign to
the parent directly affects owners equity.

Economic
Exposure

Japanese
Yen

Any depreciation in yen lowered major


competitor relative cost structure.
Impact eroding GMs market share and market
value

Translation
Exposure

Corporate Hedging Policies


Not Include
under GMs
Corporate
Hedging Policy

Economic Exposure

Definition . A firm has economic exposure (forecast


risk) to the degree that its market value is
influenced by unexpected exchange rate
fluctuations. Such exchange rate adjustments can
severely affect the firm's market share position
with regards to its competitors, the firm's future
cash flows, and ultimately the firm's value.

Economic ExposureCommercial Operating Exposure


The

policy adopted was generally to hedge 50% of all


significant foreign exchange commercial (operating)
exposure on a regional level
Each regional collected monthly forecasts (currency
pair)
A determination of riskiness
Implied risk = Regional notional exposure x Annual
volatility of relevant currency pair
Using particular derivative instrument over specified
time horizon, forward contract to hedge 50% (1st to
6thmonth) and option to hedge 50% for (7thto
till12thmonth)

Economic ExposureCommercial Capex Exposure


GM planned investments that met either of the
following two tests were hedged were hedged
with forward contracts using a 100% hedge
ratio to the anticipated payment date.
Amount in excess of $1million
Implied risk equivalent to at least 10% of the units
net worth

Transaction Exposure
Definition. A firm has transaction exposure
whenever it has contractual cash flows (receivables
and payables) whose values are subject to
unanticipated changes in exchange rates due to a
contract being denominated in a foreign currency.

It refers to the risk associated with the change in


the exchange rate between the time an enterprise
initiates a transaction and settles it.

Transaction ExposureFinancial Exposure

Generally GM was structured so as to create as


little FX risk as possible, and as a rule of
thumb they were also 100% hedged using
forward contracts.

Translation Exposure
Definition. A firm's translation exposure is the extent to which its
financial reporting is affected by exchange rate movements. As
the consolidation process for multinationals entails translating
foreign assets and liabilities or the financial statements of foreign
subsidiaries from foreign to domestic currency.
While translation exposure may not affect a firm's cash flows, it
could have a significant impact on a firm's reported earnings and
therefore its stock price.

Translation Exposure
Accounting

Treatment

FAS133, the forward and options GM would use


generally had to be marked-to-market and gains and
losses flowed through the income statement.
FAS 133 provided the possibility of hedge accounting
treatment for an exposure and associated hedge
positions

Reporting

Hedging activities were tracked and regularly


reviewed within the Treasury Group
The report was reviewed by Senior Management and
Risk Management Committee.

Risk Assessment

Identify Risk
No

Risks

Impact

GMs billion dollar exposure to the


Canadian Dollar

In income statement,
when CAD appreciate
EPS decline and vice
versa

GMs exposure to the Argentinean peso in


light of the expected devaluation in the
months ahead

Decrease shareholder
equity when
consolidated GM
report

The continuing strategic concern about


fluctuations in the Japanese Yen

Eroding GMs market


share and market
value

Risk Mapping

LIKELIHOOD

SEVERITY
Critical
(5)

Very Serious
(4)

Serious
(3)

Marginal
(2)

Negligible
(1)

Frequent
(5)

25
Operation not
permissible

20
Operation not
permissible

15
High priority

10
Review at
appropriate time

5
Risk acceptable

Moderate
(4)

20
Operation not
permissible

16
Operation not
permissible

12
High priority

8
Review at
appropriate time

4
Risk acceptable

Occasional
(3)

15
High priority

12
High priority

9
Review at
appropriate time

6
Risk acceptable

3
Risk acceptable

Remote
(2)

10
Review at
appropriate time

8
Review at
appropriate time

6
Risk acceptable

4
Risk acceptable

2
Risk acceptable

Unlikely
(1)

5
Risk acceptable

4
Risk acceptable

3
Risk acceptable

2
Risk acceptable

1
Risk acceptable

Likelihood Table
Likelihood
Level

Likelihood of Occurence/Exposure Criteria

Frequent

High likelihood of risk event happening several


times within the next year.

Moderate

A risk event is likely to occur more than once


in the next 12 months.

Occasional

Would not surprise if risk event occurred, and


will probably occur at some time in the coming
2 to 5 years.

Remote

The risk event could occur at some time but is


unlikely.

Unlikely

Within the realms of possibility but extremely


unlikely to occur. Occurs once in 10 years.

Severity Table
Severity
Level

Indicator

Critical

Bankruptcy

Very serious

Bigger debt or loss

Serious

Decreasing market share

Marginal

Instability of companys performance

Negligible

Normal company performance

Risk Assessment
No

Risk

Likelihood

Impact

Score

1 GMs billion dollar exposure


to the Canadian Dollar

2 GMs exposure to the


Argentinean peso in light of
the expected devaluation in
the months ahead

20

3 The continuing strategic


concern about fluctuations in
the Japanese Yen

12

Risk Mapping
SEVERITY
Critical
(5)

Frequent
(5)

LIKELIHOOD

Moderate
(4)

Occasional
(3)

Remote
(2)

Unlikely
(1)

Very Serious
(4)

Serious
(3)

Marginal
(2)

Negligible
(1)

Action Table
Colour

Score

Risks

Action

16-25

Critical

Action required immediately. The proposed task or


process activity must not proceed. Steps must be
taken to lower the risk level to as low as reasonably
practiable

12-15

High

High priority remedial action. Implement additional


(secondary) controls immediately. Review within 7
days. Emergency control measures shall be in place.

8-10

Medium

Take remedial action at appropriate time. Proceed


with care. Additional control is advised. Review shall
be implemented within 30 days.

1-6

Low

Risk acceptable: Residual risk. If possible, risk


reduction should be further considered, particularly
severity. There are no imminent dangers. Frequent
review shall be in place especially changes in
procedures, materials or environment.

Risk Response
Risk

Appetite
GM is exposed to financial risk as it strives to
achieve the company objectives.
GMs foreign exchange risk appetite is a high that
appropriate to expand around the world.
Risk Tolerance
A tolerance +/- 5% was therefore allowed in
matching the delta hedge ratio cover of the actual
portfolio to the cover of the benchmark portfolio.

Risk Response
List of
risk

Control Action

Canadian Hedging using forward or option contract


Options are generally better than forward contracts for
Dollar
hedging in an unstable economy

Argentina Hedging and borrowing local currency as it minimize the


level of payment that should be remitted to the parent to
Peso
net off the foreign debt

Japanese
Yen

Investment in equity stake in several Japanese company


and a financing through a yen-dominated loan like
issuing yen bonds

Risk Response- Canadian Dollar

Take remedial action at appropriate time. Proceed with care.


Additional control is advised. Review shall be implemented within
30 days.

Options are generally better than forward contracts for


hedging in an unstable economy or volatility

Risk Response- Argentina Peso

Action required immediately. The proposed task or process activity


must not proceed. Steps must be taken to lower the risk level to as
low as reasonably practiable
Hedging through long term foreign exchange swap if the company
cant withdraw the investment in long period and borrowing local
currency as it minimize the level of payment that should be remitted
to the parent to net off the foreign debt

Risk Response- Japanese Yen

High priority remedial action. Implement additional


(secondary) controls immediately. Review within 7 days.
Emergency control measures shall be in place
Investment in equity stake in several Japanese company
and a financing through a yen-dominated loan like issuing
yen bonds

Risk Map After Mitigation


SEVERITY
Critical
(5)

Frequent
(5)

LIKELIHOOD

Moderate
(4)

Very Serious
(4)

Serious
(3)

Marginal
(2)

Occasional
(3)

Remote
(2)

Unlikely
(1)

Negligible
(1)

Control Activities
Treasury

centers also monitor the economic


performance of their hedge and readjust
cover to levels which matched the levels
achieved (Delta Basis)
One of Treasury policies is evaluating the
parameters and benchmarks for managing
market risks

Information and Communication

Through reporting, the


information was made
available to senior
management and to the Risk
Management Committee to
assist in policy review and
creation.

Monitoring
Currency exposure is inevitable when doing
business in foreign markets. So GMs monitoring
through Passive Hedging Management

Monitoring (cont)
Passive Hedging Management
The second objective was a
consequence of an internal study
that determined that investment
of resources in active foreign
exchange management had not
resulted in significant
outperformance of passive
benchmarks

Conclusion
GM faces significant level of currency risk due to
geographical representation in a number of
countries
It was important to understand not just what the
policy permitted, but what the economics of each
exposure were what was best for GM as a
consolidated global entity in each case.
The company should also evaluate the economical
landscape of any country where it starts to work on
because currencies are highly volatile to the
changes in economical factors

GM can broaden the scope of hedge-able exposures


with carefully assessing the consequences

Recommendation
The company should
make centralize
treasury function
with centralized fully
and try to net-off the
amounts and should
created best possible
profitable results
according to USD not
local currencies.

The foreign exchange currency


trading market is a risky one, and
hedging is just one way that a
trader can help to minimize the
amount of risk they take on.
By utilizing a foreign exchange
hedge properly, a long foreign
currency pair, can protect from
downside risk; while a short
foreign currency pair, can protect
against upside risk.

Reference

http://www.coso.org/documents/COSO_ERM_ExecutiveSummar
y.pdf
https://en.wikipedia.org/
http://www.investopedia.com/

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