Foreign exchange hedging strategies at general motors: TRANSACTIONAL AND TRANSLATIONAL EXPOSURE
Translational exposure is the possibility of a company’s liabilities, equities, income or assets value changing because of change in exchange rates which happens if the firm has some of 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 auto mobile 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 sold in many countries. GM is therefore prone to transactional and translational exposures since it has operations in several countries and also the fact that the employees do not come from the US only because it has customers in over two hundred nations around the world. GM had an exposure worthy one billion dollars against the Canadian dollar and there was growing concern with Argentinean peso since it was expected to depreciate.
The treasurer a one Eric Feldstein was responsible for all money matters in GM as well as managing all the risks which were involved in their transactions. The firm’s executives had put in place various policies the management of exchange risks and hedging processes. Although these policies showed the way forward in treasury operations, there came an occasion and they had to change them in order to avoid massive losses. These had to be done considering the transactional and translational exposures to Argentinean peso as well as the Canadian dollar since there was an anticipated depreciation of these currencies (Pacific Basin Economic Council, 1992, pp1-11).
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 in 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 which was in charge of GM’s subsidiaries in Latin America, Africa, the Middle East and North America.
A regional treasury center for Europe and the Asian pacific
This meant that each business entity had an office which was located in a geographical area closer to it. GM’s policy for managing risk in foreign exchange was set up in order to meet three objectives which were;
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 it’s 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 which could harm the firm. Thus they ended up with using a policy which should reduce the foreign exchange risk by half. Risks were determined on regional basis, and then an evaluation was done to establish which one needed hedging. In places where a currency was seen to 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 very significant part of the entire GM since it not only supplied Canada but it was relied upon by other countries including those in North America countries and was dealing with US based suppliers. For this reason GM-Canada had its cash flow in US dollars although it hade lots of assets in Canadian dollars and for this reason there was financial exposure of the US dollar to the Canadian one. The exposure was due to the outstanding debts to Canadian suppliers the amount of money which was to be paid as pension and retirement benefits for the Canadian employees. There was a 1.7 Canadian dollar cash flow exposure projected for the next twelve months and GM’s objective was to hedge 50% of this. They wanted hedge 75% percent of this as opposed to minimum 50% 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 of they wanted to do the hedging in a cost effective manner, hence they zero rated their future contracts as at date of trade. It thus had to specifically compare the entire exposure plus a fifty percent hedge of future contracts and the total exposure in addition to a fifty percent of hedge of options (Falloon, Ahn1991, p31).
Thus at GM hedging of financial exposure was taken up very seriously and this seen by the fact that it was headed by the six of the senior most executives in the firm. This goes a long way in minimizing losses which can be due to exposures.
Desai Mihir A., Veblen Mark F. (2006) Foreign Exchange Hedging Strategies at General Motors; Transactional and Translational Exposures, Harvard, Harvard UP
Falloon William D., Ahn Mark J. (1991) Strategic Risk Management: How Global Corporations Manage Financial Risk for Competitive Advantage, California, Probus Pub. Co.
Pacific Basin Economic Council, Pacific Basin Economic Council (1992) Managing Exchange Rate Volatility, California, PBEC International Secretariat,