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Harvard Business School Case

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9-205-096

REV: MARCH 31, 2006

MIHIR A. DESAI MARK F. VEBLEN

Foreign Exchange Hedging Strategies at General Motors: Competitive Exposures

In September 2001, Eric Feldstein, treasurer and vice president of finance for General Motors, Corp., turned his attention to a long-standing strategic concern: the economic consequences of fluctuations in the Japanese yen. The yen figured heavily in the cost structures of some of GM's competitors, and Feldstein had to anticipate how exchange rate movements might impact those competitors and GM itself. Feldstein and his treasury team were responsible for managing the risks associated with foreign currency transactions and movements.1 For the most part, currency risks arising from GM's worldwide operations were managed in accordance with the company's formal hedging policy. While GM's very substantial exposure to the yen did not arise from specific foreign exchange transactions, it nonetheless presented real risks to the company. Feldstein had to understand the magnitude of the risks arising from GM's yen exposure, and to determine how best to manage those risks.

Overview of General Motors and Its Corporate Hedging Policy

General Motors2

General Motors was the world's largest automaker and, since 1931, the world's sales leader. In 2001, GM had unit sales of 8.5 million vehicles and a 15.1% worldwide market share. Founded in 1908, GM had manufacturing operations in more than 30 countries, and its vehicles were sold in approximately 200 countries. In 2000, it generated earnings of $4.4 billion on sales of $184.6 billion

1 GM's Treasury operations and its management of currency risks arising from its global operations are described in detail in

Mihir A. Desai and Mark F. Veblen, "Foreign Exchange Hedging Strategies at General Motors: Transactional and Translational Exposures, HBS No. 205-095 (Boston: Harvard Business School Publishing, 2005).

2 Statistics drawn from General Motors, 2001 Annual Report (Detroit: General Motors, 2002) and General Motors, December 31,

2001 10-K (Detroit: General Motors, 2002). ____________________________________________________________

____________________________________________________

Professor Mihir A. Desai and Research Associate Mark F. Veblen prepared the original version of this case, "Foreign Exchange Hedging Strategies at General Motors," HBS Case No. 204-024. This version was prepared by Professor Mihir A. Desai and Research Associate Mark F. Veblen. Certain figures and details have been disguised and do not reflect the actual operations of General Motors Corp. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2005 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685 begin_of_the_skype_highlighting 1-800-545-7685 end_of_the_skype_highlighting, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means--electronic, mechanical, photocopying, recording, or otherwise--without the permission of Harvard Business School.

205-096

Foreign Exchange Hedging Strategies at General Motors: Competitive Exposures

(see Exhibit 1 for GM's consolidated income statement). North America still represented the majority of sales to end customers and the largest concentration of net property, plant, and equipment (see Exhibits2 and 3), but the importance of GM's international operations was growing as a percent of the overall business.

GM's Corporate Hedging Policy

GM's global operations gave rise to significant currency risks, and the Treasurer's Office managed those risks. The key objectives of GM's foreign exchange (FX) risk management policy were to reduce cash flow and earnings volatility; minimize the management time and costs dedicated to FX management; and align FX management in a manner consistent with how GM operated its automotive business. These objectives were supported by the company's formal hedging policy. General Motors hedged cash flows (transaction exposures) only and ignored balance sheet exposures (translation exposures). The company followed a passive hedging strategy that limited management time spent on FX management, a consequence of an internal study that determined that investment of resources in active FX management had not resulted in significant outperformance of passive benchmarks. The corporate hedging policy also required foreign exchange exposures to be managed on a regional (rather than worldwide) basis, so that financial management was consistent with the operational footprint of the underlying business.3 The passive hedging policy adopted by GM was generally to hedge 50% of all significant foreign exchange exposures arising from the cash flows associated with ongoing business, such as receivables and payables. Such commercial exposures were forecast on a regional basis, and a formula was used to determine the riskiness of the exposure and the amount to hedge on a rolling twelve-month basis. The corporate hedging policy also defined the instruments used for hedging activities. Forward contracts were used to hedge exposure arising within six months, and options used to hedge exposures arising within seven to twelve months. All deviations from these guidelines had to be approved by senior executives, and Feldstein scrutinized such requests closely. Feldstein and his team also monitored foreign exchange exposures that were not covered by the company's hedging policy but could nonetheless have a direct or indirect impact on GM's business. Recently, Feldstein had paid increasing attention to the strength of the dollar against the Japanese yen and the question of how to manage GM's very substantial yen exposure. Typically, such 'competitive' exposures were discussed heuristically but the absence of analytical approaches to quantify these exposures limited the ability to implement specific hedges.

Understanding

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