Foreign exchange hedging strategies at General Motors: Transactional and Translational Exposure
Translational exposure is the possibility of a company’s liabilities, equities, income, or asset values changing because of a change in exchange rates. This happens if the firm has some assets in foreign currency. On the other hand, transactional exposure is the risk a company faces due to fluctuations in the exchange rates of other currencies after a firm has already entered into a contract.
General Motors was the biggest automobile manufacturer in 2001, controlling 15.1% of the world’s market share by selling more than eight million vehicle units. GM was started in the year 1908, and since then, it has developed with manufacturing operations in several countries, and its vehicles are sold in many countries. GM is, therefore, prone to transactional and translational exposures since it has operations in several countries. Also, the fact that employees do not come from the US only because it has customers in over two hundred nations around the world. GM had an exposure worth one billion dollars against the Canadian dollar, and there was growing concern with the Argentinean peso since it was expected to depreciate.
The treasurer, one Eric Feldstein, was responsible for all money matters in GM, as well as managing all the risks involved in their transactions. The firm’s executives had put in place various policies for the management of exchange risks and hedging processes. Although these policies showed the way forward in treasury operations, there came an occasion when they had to be changed in order to avoid massive losses. This had to be done considering the transactional and translational exposures to the Argentinean peso and the Canadian dollar, since there was an anticipated depreciation of these currencies (Pacific Basin Economic Council, 1992, pp. 1-11).
Financial risk management operations for GM were all under the risk management committee, which was headed by six of the most senior men in the firm. They met four times a year to determine the policies in place for market risk management by providing specific and detailed tools and giving appropriate time frames. There were two centers in the treasurer’s office with the sole purpose of managing all the risks involving foreign exchange. They were:
The New York Finance office was in charge of GM’s subsidiaries in Latin America, Africa, the Middle East, and North America. There was also a regional treasury center for Europe and the Asia-Pacific region. This meant that each business entity had an office located in a geographical area closer to it. GM’s policy for managing risk in foreign exchange was set up to meet three objectives:
Decreasing cash flows and income volatility.
Reducing the time and costs dedicated to the management of foreign exchange.
Have a consistent method for managing foreign exchange in its operations.
The first was for dealing with transactional exposures while leaving translational exposures, while the second involved conducting an internal study to establish the best policy at each given time to avoid employing policies that could harm the firm. Thus, they ended up using a policy that should reduce the foreign exchange risk by half. Risks were determined on a regional basis, and then an evaluation was done to establish which one needed hedging. In places where a currency was seen as highly volatile, hedging was done for the coming six months rather than twelve, and this went a long way in reducing the risk to five million dollars. The hedging policies were followed closely and reviewed to meet the required standards.
GM-Canada was a significant part of the entire GM operation since it not only supplied Canada, but it was also relied upon by other countries, including those in North America. GM-Canada dealt with US-based suppliers, which meant that its cash flow was in US dollars, despite having many assets in Canadian dollars. This created financial exposure of the US dollar to the Canadian one. The exposure was due to outstanding debts to Canadian suppliers and the amount of money that was to be paid as pension and retirement benefits for Canadian employees. A cash flow exposure of 1.7 Canadian dollars was projected for the next twelve months, and GM’s objective was to hedge 50% of this. They initially wanted to hedge 75%, but after calculations, it emerged that this could result in a loss. Due to the fact that GM’s hedging policies were in terms of large amounts, they wanted to hedge in a cost-effective manner. Hence, they zero-rated their future contracts as of the date of trade. They had to specifically compare the entire exposure plus a 50% hedge of future contracts and the total exposure in addition to a 50% hedge of options (Falloon, Ahn 1991, p.31).
Thus, at GM, hedging of financial exposure was taken up very seriously. This is evidenced by the fact that it was headed by six of the most senior executives in the firm. This goes a long way in minimizing losses that can be due to exposures.
References
Desai, Mihir A. and Veblen, Mark F. (2006). Foreign Exchange Hedging Strategies at General Motors: Transactional and Translational Exposures.” Harvard University Press.
Falloon, William D. and Ahn, Mark J. (1991). Strategic Risk Management: How Global Corporations Manage Financial Risk for Competitive Advantage. California: Probus Publishing Company.
Pacific Basin Economic Council, Pacific Basin Economic Council (1992): Managing Exchange Rate Volatility. California: PBEC International Secretariat.
