This case study entitled "Foreign Exchange Hedging Strategies at General Motors" discusses the policies employed by General Motors with regard to its foreign exchange hedging strategies. It seeks to look deeper into such strategies to see if there is a need to deviate from its implementation.
Mihir A. Desai; Mark F. Veblen
Harvard Business Review (204024-PDF-ENG)
March 01, 2004
Case questions answered:
- Should multinational firms hedge foreign exchange rate risk? If not, what are the consequences? If so, how should they decide which exposure to hedge?
- What do you think of the foreign exchange hedging strategies at General Motors? Would you advise any changes?
- Please quantitatively analyze the sensitivity of exposure, that is, using two tables showing (1) hedging ratio scenarios for transactional CAD exposures (2) impact of hedging on EPS.
- Should GM deviate from its policy in hedging its CAD exposure? Why or why not?
- If GM deviates from its former policy for its CAD exposure, how should GM think about whether to use forwards or options for the deviation from the policy?
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Case answers for Foreign Exchange Hedging Strategies at General Motors
This case solution includes an Excel file with calculations.
1. Should multinational firms hedge foreign exchange rate risk? If not, what are the consequences? If so, how should they decide which exposure to hedge?
Definitely, we think that firms should engage in foreign exchange hedging strategies because hedging foreign exchange risks results in a reduction in risk of future cash flows and this improves the planning capability of the firm. If a firm can more accurately predict future cash flows, it will also be able to evaluate specific investments that can maximize shareholder’s wealth more precisely.
Furthermore, a reduction in the risk of future cash flows reduces the likelihood that the firm’s cash flow will fall below a level sufficient to make interest and loan repayments required for continuous operations. The management of the firm should know the actual risk of the firm so they can be well prepared for other risks involved.
On the other hand, if the firm does not hedge, they would be fully exposed to currency risk and they might not able to prepare enough money to repay the debt as they could not forecast their future cash flow related to the exchange rate.
If a company decides to hedge its foreign exchange rate risk, they should hedge transaction and operating exposures only. As compared to a translation exposure which only impacts the financial statements, transaction and operating exposure have real economic consequences since these two exposures both affect the cash flows of the firm.
2. What do you think of the foreign exchange hedging strategies at General Motors? Would you advise any changes?
General Motor’s overall foreign exchange risk management policy was established to meet three primary objectives which include…