Foreign Exchange Hedging Strategies at General Motors: Transactional and Translational Exposures Competitive Exposure

Foreign Exchange Hedging Strategies at General
Motors: Transactional and Translational Exposures
Competitive Exposure
About General Motors (GM) and its Foreign Exchange Policy
Since the early 1930, General Motors has enjoyed the status of being one of the largest card manufacturers in the world. As per the financial statements of 2000, GM earned a net profit of $4.4 billion on sales of $184.6 billion. Though the company enjoyed selling majority of its production in USA, it is fast getting its foothold in the international market and it has also reached to the level of 18% of the total sales.
Following are the objectives of the GM’s foreign exchange risk management policy:
Reduction in cash flow and earnings volatility
To save the valuable management time
Reduce the costs directly associated with FX management
As of now, the company has only been managing the cash flow exposure (which is transaction exposure) and not the balance sheet exposure (which is translation exposure). The company had adopted the policy of hedging the 50% of all the significant foreign exchange exposure arising out of receivables and payables. For the exposures arising with in the six months, the company has adopted to hedge through forward contracts and in respect of the exposure from seven to twelve months, the company has adopted to hedge the risk through options.
The overall exposure of GM through forecasted receivables and payables is that of $900 million. 
GM’s Competitive Exposure
The major competitors of GM are the Japanese companies like Toyota and Honda which are fast having their presence felt in the US automobile industry. A larges part of their costs of manufacturing consists of Yen and any fluctuations in Yen vs. Dollar seriously affect their operating profits. As of year 2000, the Japanese companies can not afford to ignore the US market as 43% of their earnings comes from US alone. With the appreciation of Japanese Yen from 117 to 107, the combined global profits of the company were reduced by $4 billion.
Depreciation of the yen would lead to reduced costs for Japanese automakers (since 20% to 40% content was sourced from Japan). 15% to 45% of this cost saving would be passed on to the customer. Customer sales elasticity as measured by GM indicated that a 5% price decrease would increase unit sales by around 10%. This market share gain by Japanese automakers would be shared equally and entirely by the Big Three in Detroit.
Quantification of the Competitive Exposure of GM
Assumptions:
Japanese car makers source 40% content from Japan (worst case scenario).
Japanese carmakers pass on the cost savings to their customers up to 40 – 45% (worst case scenario).
Devaluation of Yen by 20% in comparison to the dollar (worst case scenario).
Total cost per car is $20000 (assumed). The margin obtained by GM is approximately $5900 ($1969 * 3) on the cost. Due to competition, Japanese carmakers would also need to price their vehicles similarly. Hence the same price is assumed for Japanese carmakers as well.
Loss is valued as perpetuity at 20% discount rate.
Japanese carmakers
General Motors
Cost of Car
$20,000
Price of car
$25,900
Component cost (of Japanese component) at old exchange rate of $1=100¥ (40% components sourced from Japan)
¥800,000 = $8000
Component cost at new exchange rate of $1=120¥
¥800,000 = $6,666.67
Change in profit margin
$1,333.33
Addl. Margin passed on to customers ( = 45% of change in profit margin)
$600.00
 New price of car
$25,300
Price decrease
2.32%
Increased sales (elasticity = 2)
4.63%
Sales in 2000
4100000
Increase in sales in 2001 (Gain by Japanese carmakers shared by Big Three)
189962
-63321
Income loss for 2001
-$249,358,098
Income loss for perpetuity (Discounting at 20%)
-$1,246,790,490
Thus there is a loss of $1.24 billion to GM which they can not definitely afford to ignore.
The above calculations do not include the growth in respect of the various variables and the market at large. 
Sensitivity Analysis
 	We have conducted an sensitivity analysis to judge the varying Yen/Dollar exchange rates. The range is from $1 = 120 Yen to $1 = 80 Yen. Also the content sourced from Japan has been varied from 20% to 40%. Varying these parameters, we get the values for income loss/gain for 2001. These values are discounted at 20% to find out the loss/gain to perpetuity. In this analysis, the margin passed on by Japanese carmakers has been fixed at 45%.
Exchange Rate: $1= 
120 ¥
100 ¥
90 ¥
80 ¥
Japanese content
20%
-$623,405,090
0
$415,596,830
$935,097,790
30%
-$935,097,790
0
$623,405,090
$1,402,636,840
40%
-$1,246,790,490
0
$831,193,660
$1,870,175,890
Another sensitivity analysis has been carried out, wherein the Japanese content in the automobiles is varied from 20% to 40% and the margin passed on by Japanese carmakers to customers has been varied from 15% to 45%. Here the exchange rate has been kept constant at $1 = 120¥
Japanese content 
20%
30%
40%
Margin passed on by Japanese carmakers to customers
15%
-$207,808,260
-$311,712,390
-$415,596,830
30%
-$415,596,830
-$623,405,090
-$831,193,660
45%
-$623,405,090
-$935,097,790
-$1,246,790,490
In the above case, the erosion has ranged from -$208 to -$1.25 billion
Recommendations:
From the above analysis done, the following course of action (s) can be suggested to GM:
Shifting some of its production to Japan
Source the parts from Japan
The above mentioned suggestions have long term implications and involve lot of other issues like tax structure, barrier to entry, capital expenditure and the like. The company can not just take these decisions for just hedging purposes. It is suggested that the management of GM should thoughtfully and carefully examine all the points. 
The current GM policy does not know how to deal with the competitive exposure. One of the very good suggestions could be that GM can increase its Yen borrowings which would also act as the natural hedge to any depreciation in the Yen and would also not require the use of complex derivatives.