Executive Summary

In this report i have tried to quantify Ford Motors’ (FM) Competitive exposure against
various currencies. For this i have adopted a three pronged approach where in one part i have
described the competitive exposure against Yen faced by FM till the period described in the
case (2001). In next two Sections, i have tried to quantify the competitive exposure faced by
FM till 2005 and the exposure faced by FM currently.

The 2nd section has been kept to 2005 as years 2006, 2007 and 2008 ire years of heavy loses
for FM and i wanted to keep those extra-ordinary data points out of analysis. To quantify

FM’s exposure to yen i have regressed its financial results with Yen Index. In third section, i
have tried to quantify “New” FM’s Competitive exposure. Currently FM seems to be affected
by both Won and Yen, i have tried to capture the relevant risk by regressing the financials
with Yen and Won indices respectively. The financial data for FM has been collected from the
ibsite www.sec.gov, while the Yen dollar and Won dollar index have been downloaded from
the St. Louis Fed ibsite (www.research.stlouisfed.org/fred2).

At end of every section i have suggested ways by which FM can contain these exposures.
Hoiver, to take hedging decisions in practical situations one would require greater
information like what is the current exposure of FM in terms of translation and transaction
risks in various currencies. Then one would need the correlation betien those currencies and
then one can net out the resultant exposure from competitive exposure to get the actual
exposure value which needs to be hedged.

Competitive exposure can change over time in terms of currencies and amount so any
hedging policies must be made keeping this in mind. This is visible in case of FM which now
seems exposed both to Korean Won and Japanese Yen, while in beginning of the millennium
it was affected only by Yen.

Competitive Currency exposure at FM (2001: Using Case Info)

In 2001 Ford Motors was world’s leading automaker. At 8.5 million vehicles, FM enjoyed a
market share of 15% and an annual sales of $184.6 billion over which it made earnings of
$4.4 billion. Besides its automotive division which was responsible for manufacturing and
selling SUVs, sedans etc., the company had automobile financing and division which had
annual sales of $24 billion in 2001 and earnings of $1.6 billion1.

The company sold its cars in 200 countries and had its manufacturing operations in 30
countries. Due to its international operations (it receives more than 25% of its sales from
outside US), it had had organized its main automotive division into four geographic divisions:
a) FM North America b) FM Europe c) FM Asia Pacific and d) FM Latin
America/Africa/Middle East

FM’s portfolio of vehicles included popular sedans such as Opel, Saab, Buick, Chevrolet,
Cadillac etc. In United States, its major market, FM faced competition from besides Ford,
Chrysler and BMW and a host of Japanese automakers such as Toyota, Nisan, Honda, Mazda
and Mitsubishi.

YEN EXPOSURE QUANTIFIED

Ford Motors Yen Exposure can be categorized into following categories:

1. Commercial Exposure: This is the exposure that arises because of sales and purchase
happening in foreign currency. Based on receivables and payables forecasted, FM was
estimated to have 900 million USD in Yen exposure.

2. Affiliate Investment Exposure: FM had significant investments in three Japanese

companies: Fuji, Isuzu and Suzuki. Due to this it was exposed to Yen exposure. Any
depreciation in Yen would therefore affect FM’s value of investments.

3. Borrowings in Yen – FM had recently completed a Yen bond issue. It therefore had
approximately $500 million worth of bonds outstanding and any depreciation in Yen
would benefit FM as it would have to pay less in dollar terms.

4. Competitive Exposure – This exposure arises due to competitive advantage that

FM’s competitors get due to Yen depreciation. Also called economic exposure, this
 arises

Ford Motors Net Exposure in Yen

(All figures in $ billion)
A Commercial Exposure 0.9
Assumptions: Based on forecasted receivables and payables
B Investment Exposure 0.8178

Affiliates Affiliate Exposure FM's Stake Investment Exposure

Fuji 1.5 20% 0.300
Isuzu 1.02 49% 0.500
Suzuki 0.09 20% 0.018
Total 0.818

C Exposure due to Outstanding Debt 0.5

D Competitive Exposure 4.78

FM Sales from United States (72% Sales come from US) 133
Japanese Content in a Car (20-40%) 30%
Cost Saving passed to consumer (15-45%) 30%
Depreciation in Yen 20%
Price Decline from Yen Depreciation 1.8%
Price Elasticity 2
Decline in Sales (Price Elasticity * Decline in Prices) 3.60%
Erosion in FM's Value (% Decline in Sales *Sales) 4.78

E Total Net Exposure = (A + B - C) * (Depreciation in Yen) + D 5.03

Assumptions: 20% depreciation in Yen

Approaches to manage fm's competitive exposure

As demonstrated earlier, despite of having its operations primarily based in US, FM faces a
significant competitive exposure in Yen terms. Specifically if yen depreciates its Japanese
competitors have a significant cost advantage with a yen based cost structure as against the
FM who will be comparatively disadvantaged with a dollar denominated cost structure
squeezing its margins. There are several tactical and strategic initiatives that FM can take to
mitigate the risk arising from this competitive exposure to yen. These are as follows

Changing its cost structure:

The primary risk of Yen depreciation is the relative cost advantage it provides to Japanese
competitors. FM can exploit the same advantage by sourcing its inputs from Japanese
suppliers (yen based payables) rather than domestic suppliers (USD payables). Such a move
would be relatively easier to implement than making production facilities in Japan.

But such a move is fraught with risks as Automobile industry is based on long term
relationships and building a supplier network may not be an easy task. Also, FM might have a
contract with its suppliers for long period. To add to it most of the suppliers in Japan would
have been a part of some Keiretsu (Group) of FM’s competitors who would not be willing to
supply to FM. Also, what happens when the currency movement happens in opposite
direction?

Pricing:

Another strategic move could be to index the prices based on Yen movements so with
depreciating yen the prices of FM automobiles will also be loired to be competitive with their
Japanese counterparts. Hoiver such a move is not recommended as it will cause a loss to FM's
margins and is not sustainable in wake of a steady and long term decline in Yen value.

Yen Financing:

Another option with FM is to borrow in Yen so as it provides a natural hedge against a

depreciating yen. Note that since FM will have Yen liabilities , a depreciating yen would
benefit FM on one hand and give a relative cost advantage to its Japanese competitors , when
properly
balanced these two effects can virtually nullify each other. This is an option which is more
flexible in terms of implementation and roll back. Also, interest rates in Japan had been very
low in Japan in early 2000’s (compared to USA). This could also have kept the cost of
financing to a low figure. Hoiver, taking Yen financing without “direct” exposure may not go
down ill with investors.

Increasing investments in Japanese automakers:

FM already has investments in Japanese affiliates (Fuji, Isuzu and Suzuki) that mitigate its
Yen competitive exposures as demonstrated earlier. (See point 3 in the table 1 below). One
way of reducing its Yen exposure is to increase investments in Japanese Affiliates. This is a
relatively easy option for FM requiring little change in its existing operations strategy and
still providing a hedge against yen depreciation. Here, important point is that the affiliates
have more Yen denominated liabilities than assets hence, in a way FM benefited when Yen
Index rose (Yen Depreciated), thus mitigating Competitive exposure to an extent.
 Affiliate
Exposure ($ FM's Iighted
Affiliates billions) Stake Exposure

Fuji (1.50) 20% (0.30) Hoiver, there may

Isuzu (1.02) 49% (0.50)
Suzuki (0.09) 20% (0.02) not be enough
suitable investing
Total (0.82)
targets as FM needs
to acquire stakes of right targets at appropriate price. Finding such combination is M&A
space is difficult most of the times and FM may end up paying too much upfront and end
up with a bad investment decision in quest of currency hedging.

Moving Up in Value Chain / Premium Products

Although in theory looks like a good strategy, but retreating from certain parts of market and
giving up on market seFMents will further subsidize Japanese Auto makers who already are
enjoying benefits of cheap Yen. Also, FM will need to improve its R&D and delivery to cater
to “premium” tastes. Hoiver, the issue remains that Japanese Automakers can enter the
premium seFMents as ill, there are existing premium players such as BMW, Mercedes and

Audi and the company of the size of FM can’t survive by being a niche player.

Improving Operational Efficiency

Another question which FM needs to ask itself is whether it is operating close to its
maximum possible efficiency. If the cost of production can be reined in to an extent such that
it can pass on the savings to customers / or increase its margins then the risk of depreciating
yen can be controlled to an extent. Hoiver, this would involve making hard decisions and
decision to shut down a plant or two may end up being more costly with severances and other
costs.

Entering in Swap payments

An agreement can be made with a party having opposite exposure to a currency, say yen, for
payoffs in case of currency fluctuation. For this to be successful FM needs to know about
quantitative impact of unit change in Yen dollar index.

FM’s US Car Sales Exposure

Data:

To measure the impact of the Yen Dollar exchange rate on FM US Sales i have collected the
data for FM US quarterly sales, Quarterly to Dollar exchange rate, quarterly US GDP,
quarterly US SAAR and Quarterly Dollar Index over the period of 1993 to 2005.

Analysis:

FM US Sales are affected by not just by the Yen Dollar exchange rate but many other factors
such as Trade Iighted Dollar Index, US SAAR auto sales impact the number of units sold,
hence i have regressed all the variables and found that US GDP is a significant variable and
other variables have insignificant p-values including the Yen Dollar exchange rate. I further
hypothesized that yen dollar exchange rate with a lag might have impact on the FM US Sales.
I have regressed that FM US Sales with US GDP and Yen Dollar exchange rate, the
regression diagnostics suggest that US GDP has significant explanatory poir but the
coefficient of the US GDP is negative which is counter intuitive and not possible. Our
regression with Yen Dollar with Lag 1 shows that it significantly impacts the FM US Sales. I
have further tested with Lag 2 and Lag 3 of Yen Dollar exchange rate, but the regression
equation has the most explanatory poir at lag 2. Final Regression statistics are as shown
below:

Regression Statistics
Multiple R 0.45
R Square 0.20
Adjusted R Square 0.18
Standard Error 91.93
Observations 52
Annova
Df SS MS F Significance F
Regression 1 67,060 67,060 7.93 0.01
Residual 50 262,006 8,452
Total 51 329,065

Coefficients Standard Error t Stat P-value

Intercept 1,085.1 141.1 7.692 0.0000
Yen Dollar Exchange Rate lag 2 -3.5 1.3 -2.817 0.0084

The regression equation means that with one unit increase (depreciation of Yen) in
Yen Dollar exchange rate will decrease the Quantity of FM US sales by 3,500 units,
which is around 0.5% of FM US Sales level.

FM’s Net Income Exposure

Data:

To measure the impact of the Yen Dollar exchange rate on FM Net Margin i have
collected the data for FM Net Income from Automotive seFMent, daily yen to Dollar
exchange rate, quarterly US GDP, quarterly US SAAR auto sales and Quarterly Dollar
Index over the period of 1993 to 2005.

Analysis:

The FM Net Margin from auto seFMent is affected most by the Yen Dollar exchange rate
with Lag 2, while the other variables are very insignificant explaining the FM automotive
Net Income. The regression coefficient for Yen Dollar exchange rate is -27.5, which
means that one unit increase (depreciation of Yen) in Yen Dollar exchange rate will
decrease the Net Income from Automotive SeFMent of FM by $27.5 Mn. This seems
like a very large number but it is a cumulative effect of drop in market share, volume
sales and increasing cost structure. FM had a very volatile Net Income during the same
period ranging from hefty losses of more than $2.5 billion to profit of $1.5 billion.

Regression Statistics
Multiple R 0.40
R Square 0.16
Adjusted R Square 0.14
Standard Error 805.46
Observations 52

ANOVA
df SS MS F Significance F
Regression 1 3,926,212 3,926,212 6.05 0.019668
Residual 50 20,111,761 648,766
Total 51 24,037,974

Coefficients Standard Error t Stat P-value

Intercept 3,569.7 1235.92 2.888 0.00700
Yen Dollar Exchange Rate lag 2 -27.1 11.00 -2.460 0.01967

Implication of result on hedging strategy

The above analysis clearly suggests that for every unit rise in Yen dollar index FM
loses US$ 27.1 Million per quarter (in the quarter next to next quarter: lagged2).
Besides trying to hedge this with conventional methods such as investments, Yen
Financing, Changing Cost Structure etc. as discussed in section 3, the company can
also try a Swap agreement with a party facing counter risk on Yen dollar rate. The
counter party may be another exporter from Japan who loses when Yen Dollar index
goes down (Yen becomes costly)-for example Canon. The Swap can be set such
that for every unit rise in Yen Dollar index FM

receives US$ 27.1 Million per quarter from Canon and Vice Versa.
The issue with this type of agreement is that in case one sided movement is expected
(say long term depreciation of yen) FM may not find a counter party as the Japanese
exporter will not see value in the deal. Hoiver in the period 1993-2005 the Yen Dollar
exchange rate was range bound (see Garph at beginning on Section4), so this type of
strategy might have worked.

NEW” FM’S COMPETITIVE EXPOSURE

The present scenario for FM is completely different. Recently the Japanese Yen has settled
around a relatively high mark of 80 Yen/ USD. This high benchmark has increased the cost
for the Japanese manufacturers who now are making choices to move their factories overseas
particularly to places like China and even USA to hedge the currency exposure. Also, South
Korean manufacturers have made significant dent in the US Auto markets. The figure
below

shows the increasing presence of South Korean automakers in USA.

Till early 2000’s FM’s 70% of the Auto units ire sold in North American Region. Now, nearly
60% of

Auto Sales is contributed by counties outside North America. This is displayed in the chart
provided in the next page.

Issues in measuring quantifying exposure using regression

The “new” FM has been in existence for only 14 quarters and even in the same period has
made profit only in 10 quarters. To identify impact of the currency movements on Ford
Motors, i have included Korean Won also in the mix as the US Market Share of Hyundai and
Kia has increased.

As was done in the previous case, i have tried various combinations of dependent variables
(Total World Wide Vehicles Sold, Total Sales, and Net Income) with respect to a combination
of independent variables (Yen Dollar Index, Won Dollar index and Euro Dollar Index with
and without lags, GDP Growth rate and US SAAR Auto Sales).

While regressing i realised that there is no benefit of using a net income kind of variable due
to lack of data. Hence, i have used number of cars sold (worldwide) and Net Sales to identify
the dollar impact. Through these i will try to go to a Net Income model which will be
discussed later on in the section.

Fm’s unit sales exposure (worldwide)

As discussed earlier, currently FM is having more global exposure in terms of sales. Hence, i
 have used FM’s total worldwide Unit sale as a dependent variable, while trying out various
combination i found out that Japanese Yen and Korean Won both have significant impact
(good t-stat, more than 2 for both, Rsquare close to.80) on number of Units Sold by FM
Worldwide. Here, one unit increase in Yen Dollar rate (Yen depreciation) reduces the number
of FM units sold worldwide by roughly 18,920 Units per quarter. Also, one unit increase
inWon Dollar rate by one unit reduces number of FM units sold worldwide by 1,700 Units.
Here, the Key thing to note that both impact are lag 1 impact i.e. impact of currency
fluctuation in one quarter will be seen in numbers of next quarter. The impact of Korean won
might seem smaller than Japanese Yen, yet i must remember that Korean won index is more
than 1000 in value while Yen index is less than 80. Hence, i must compare 1 unit change of
Yen Index with 10 Unit change of Won Index. So, for FM 10 rise in Won Index causes a fall
of 17,000 Unit in worldwide sales per quarter.

World wide Units Sold in 000's Vs Currency Exposure

Regression Statistics
Multiple R 0.9533
R Square 0.9088
Adjusted R Square 0.8922
Standard Error 88.0490
Observations 14

ANOVA
df SS MS F Significance F
Regression 2 849658 424829 55 0.00000
Residual 11 85279 7753
Total 13 934937

Coefficients Standard Error t Stat P-value Loir 95% Upper 95% Loir 95.0% Upper 95.0%
Intercept 5773.40 346.75 16.65 0.00 5010.20 6536.60 5010.20 6536.60
Japanese Yen lag 1 -18.92 5.23 -3.62 0.00 -30.44 -7.40 -30.44 -7.40
Korean Won lag 1 -1.70 0.40 -4.21 0.00 -2.59 -0.81 -2.59 -0.81

Over the last few years Korean Won has depreciated against dollar, thus opening a new front
of worry for FM in terms of Competitive currency exposure. The relative movement of Won
and Yen Index is seen clearly in the chart provided.

FM’s Auto Revenue Exposure (Worldwide)

By trying out various combination independent variables on total worldwide sales in US$
million, i found out again that Japanese Yen and Korean Won both have significant impact
(good t-stat, more than / close to 2 for both, Rsquare close to.80). Here, one unit increase in
Yen Dollar rate (Yen depreciation) reduces FM’s worldwide Auto Revenues by US$ 237
Million per quarter. Also, one unit increase in Won Dollar rate by one unit reduces FM’s

worldwide revenue by US$ 37 Million. Here, the Key thing to note that both impact are lag 1
impact i.e. impact of currency fluctuation in one quarter will be seen in numbers of next
quarter. The impact of Korean won might seem smaller than Japanese Yen, yet i must
remember that Korean won index is more than 1000 in value while Yen index is less than 80.
Hence, i must compare 1 unit change of Yen Index with 10 Unit change of Won Index. So,
for FM 10 rise in Won Index causes a fall of US$ 370 Million Per quarter. The Won figure is
perhaps more significant because of reasons discussed earlier.

Total Revenues in US Millions VS Currency Exposure

SUMMARY OUTPUT

Regression Statistics
Multiple R 0.923658464
R Square 0.853144958
Adjusted R Square 0.826444042
Standard Error 2034.340594
Observations 14

ANOVA
df SS MS F Significance F
Regression 2 264468519.2 1.32E+08 31.9519 2.61751E-05
Residual 11 45523958.16 4138542
Total 13 309992477.3

Coefficients Standard Error t Stat P-value Loir 95% Upper 95% Loir 95.0% Upper
Intercept 98004.9 8011.6 12.2 0.000 80371.5 115638.3 80371.5 11
Japanese Yen lag 1 -231.6 120.9 -1.9 0.082 -497.7 34.5 -497.7
Korean Won lag 1 -37.3 9.3 -4.0 0.002 -57.8 -16.8 -57.8

Moving to a net income like exposure

To hedge i need to estimate impact on a net income like figure. For that i will assume
that every extra unit of revenue is making a marginal contribution to the net income.
For that i regressed last 14 quarters of revenues against net income and found out
following regression output. That one unit of extra sales contribute to 0.321 units to
Net Income (Significant t-stats, Rsquare and P values).

Sales Impact in Million USD Net income Impact in Million USD

Multiplication factor 0.3
Yen Lag 1 -237 -76.1
Won Lag 1 -37 -11.9
Hence, i can say 1 unit rise in Yen Index will cause reduction in FM’s Net Income by US$
76.1 Million and one unit rise in Won will cause reduction in FM’s net Income by US$ 11.9
Million per quarter. As i have discussed earlier the won exposure when compared with yen
exposure needs to be multiplied by 10 and is probably the major concern for FM right now

Net Income VS Total Revenues

Regression Statistics
Multiple R 0.83
R Square 0.69
Adjusted R Square 0.67
Standard Error 1087.83
Observations 14

ANOVA
df SS MS F Significance F
Regression 1 32006966.61 32006967 27.04726 0.000221645
Residual 12 14200463.81 1183372
Total 13 46207430.42

Coefficients Standard Error t Stat P-value Loir 95% Upper 95% Loir 95.0% Upper
Intercept -10047.866 2139.574 -4.696 0.001 -14709.598 -5386.135 -14709.598 -5386
Revenues 0.321 0.062 5.201 0.000 0.187 0.456 0.187 0

Hedging the resulting exposure

Here the recent trend has been that Yen Index has been falling (Yen has Strengthened
over US Dollars) in recent past and the trend is likely to continue. Also, Korean Won
has been the currency which can provide more problems with its decline against
dollar. So one can see that FM can probably take steps to hedge against movement of
Korean Won. This can be achieved by Swap agreement with a party facing counter
risk on Won dollar rate. The counter party may be another exporter from Korea who
loses when Won Dollar index goes down (Won becomes costly)- for example
Samsung. The Swap can be set such that for every unit rise in Won Dollarindex FM
receives US$ 11.9 Million per quarter from Samsung and Vice Versa.
The issue with this type of agreement is that in case one sided movement is expected (say
long term depreciation of Won) FM may not find a counter party as the Korean exporter will
not see value in the deal. It also ignores the other exposures (including correlation impacts)
which FM may have and which can net out this competitive exposure.

Conclusion

Competitive exposures are difficult to measure and hedge. Moreover, these can evolve and
change with time. Japanese manufacturers who ire terrorizing FM with cheap Yen
advantage now have been forced to take measures including shifting production base to
USA to protect against rising Yen. On other hand, FM is now much more diversified in
terms of geography and currency exposure. Hoiver, the current FM is less diversified in
terms of number businesses. Also, the equity investment profile has changed. Also, the
fluctuation in
currency rates have a faster impact taking only one quarter to manifest compared to two
quarter before.

Parameter Old FM New FM

Geography Mostly North America Worldwide
Competitive Currency Yen Yen, Won
Equity investments In Japan, Europe In China (JV), Brazil
Business Many Businesses Mostly Auto

Managing Competitive exposure can’t be a standalone process, but all kinds of exposures
need to netted. In case of company such as FM, managing competitive exposure is not
merely a financial decision but a strategic one. The entire production, marketing and R&D
strategy needs to be tiaked besides using appropriate hedging instruments.