Gm Case Study

1. List the three distinct types of risks from foreign currency fluctuations?

There are three distinct types of risk from foreign currency fluctuations.  First, transactional exposure (short term) impacts cash flows. These are the gains and losses that arise when transactions are settled in some currency other than a company’s reporting currency. One key objective of the GM hedging strategy was to reduce cash flow and earning volatility. Foreign exchange exposures were to be managed on a regional basis. They used a company wide formula to determine exposure and amount to hedge on a rolling twelve month basis. The company generally hedged 50% of all significant foreign exchange exposures arising from cash flows associated with ongoing operations. Second, economic exposure for capital projects (long term). As exchange rates vary the NPV of a project can change. GM uses forwards contracts and options. Finally, translation exposure (balance sheet). Not included in GM’s hedging policy. This affects a firm’s consolidated financial reporting, and arises when the assets and liabilities of a multinational’s foreign subsidiary are translated back into the multinational’s reporting currency.

2. What is different about competitive exposures compared to the other types of exposures you have listed in answer to question 1. Identify 5 differences.

Competitive exposure does not arise directly by the multinational’s inflows or outflows, but it arises by the effect of competing companies that have different home currencies. There is no direct foreign exchange effect on the multinational’s balance sheet or financial statement. The main effect of competitive exposure is on the company’s market share that will be affected by the better (or worse) condition of the competitor’s sales, which stems from the depreciation (or appreciation) of the competitor’s home currency. Depreciation in the Yen led to additional gross margin per vehicle, some of which was passed along to customers. Estimating the magnitude of competitive exposure depends on a number of assumptions and involved a fair amount of guesswork, making them more hard to quantify than other types of fx exposure. Competitive exposure complexities are shown in the case by the fact GM did not have a formal policy. Rather managers would discuss practical solutions to overcoming depreciation in foreign competitor’s home currency.

3. Calculate GM’s competitive exposure to the Yen using the following steps (numerical calculations required)

We will start by assuming that the yen depreciates 20% against the USD.

a. Step 1: Costs drop for Japanese Automakers: How much do costs decline?

The average Japanese car had between 20% and 40% Japanese content. We will take a midpoint of (20% + 40%) / 2 = 30% (yen outflow for the Japanese automaker.

A 20% depreciation in the yen against the USD will lead to the following effect:

• Let USDJPY = X, JPYUSD = 1/X
• New USDJPY = 1.2X, JPYUSD = 1/1.2X
• Change percent = (1/X - 1/1.2X) / 1/X = 1 - (1/1.2) = 1 - .833 = 16.67 % cost savings on the Japanese content only (the Japanese will save 16.67% on 30% of each car): 16.67% X 30% = 5% savings on each car’s cost of production.

b. Step 2: Japanese Manufacturers pass on some of their cost savings to consumers, lowering the price of Japanese cars sold in US: How much are prices lowered?