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

FIN 649 Case 1

Foreign Exchange Hedging Strategies at General Motors:

Transactional and Translational Exposures

1. Why do companies hedge?

With the development of GM, it expanded business around the world. Its exposures risk to foreign currencies grew. Exchange rate changes create gains and losses that affect company’s income. Increasing the volatility of profit.

2. What are the different types of foreign exchange risks?

GM faces transactional exposure, translational exposure, and commercial exposure. Transactional exposures are gains and losses that happen when transactions are settle using foreign currency other than company’s domestic currency. These exposures come from purchasing, selling activities and financing such as borrowing.

Translational exposures are gains and losses that happen when the assets and liability of foreign subsidiaries are translated into domestic currency for the purpose of preparing consolidated financial statements.

Commercial exposures: with operation, sales units, and investments spanning the globe, GM had direct and indirect commercial exposures virtually to foreign currencies.

3. What has to be considered in developing a hedging policy?

GM senior executives had established a number of formal policies with respect to foreign exchange risk management and hedging procedures. However, on occasion situations arose that required special attention and probably a deviation from the stated policy.

Treasury policy included evaluating the parameters and benchmarks for managing market risks, determining criteria for accessing counterparty credit risk, determining threshold for property and liability insurance coverage, as well as reviewing internal control aspects of operating policies and procedures.

FX hedging activities were segregated in this way on the principle that should be some geographic correspondence between where a business unit was actually managed and where treasury for that business was controlled.

The primary objectives of hedging policy: 1) reduce cash flow and earning volatility. 2) minimize management time and costs dedicated to global FX management. 3) align FX management in a manner consistent with how GM operates its automotive business.

4. Should multinational firms’ hedge foreign exchange rate risk? If not, what are the consequences? If so, how should they decide which exposure to hedge?

Yes, company should hedge foreign exchange rate risk. If not, company may experience losses when foreign exchange rate fluctuates. Because the global transaction scale of GM is huge, even though the percent changes of exchange rate is small, it can cause tremendous loss due to big magnitude.