Foreign exchange hedging strategies at general motors

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Foreign Exchange Hedging Strategies at General Motors
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Summary
Overview of General Motors and its Treasury Operations
General Motors
General Motors was the world’s largest automaker, with unit sales of 8.5 million vehicles in 2001-15.1% worldwide market share-and
had been the world’s sales leader since 1931. Founded in 1908, GM had manufacturing operations in more than 30 countries, and its
vehicles were sold in approximately 200 countries. In 200, it generated earnings of $4.4 billion on sales of $184.6 billion. The labor
costs for its 365,000 employees in that year amounted to $19.8 billion, only $8.5 billion of which was for U.S.-based personnel. In
addition to vehicles, other major product lines included:
(i) financial services for automotive, mortgage, and business financing, and insurance services through General Motor
Acceptance Corporation (GMAC),
(ii) satellite television and commercial satellite services through Hughes Electronics, and
(iii) locomotives and heavy duty transmissions through GM Locomotive Group and Allison Transmission Division.
GM traded on the New York Stock Exchange and was a component of the Dow Jones Industrial average.
While North America still represented the majority of sales to end customers and the largest concentration of net property, plant, and
equipment, the importance of GM’s international operations was growing as a percent of the overall business. With globalized
production, these figures understated the degree to which intermediate goods in GM’s supply chain moved around the world. Its

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market share in Latin America was 20% and in Europe had reached 10% (20% and in Europe had reached 10% (20% if Fiat’s figures
were included). Increasing market share in Asia, which stood at 4%, was a major strategic objective for GM.
General Motors Treasurer’s Office
Various groups within the Treasurer’s Office were involved in the implementation of financial risk management policy. For foreign
exchange, all of GM’s hedging activities were concentrated in two centers:
 The Domestic Finance group in New York handled FX hedging for GM entities located in North America, Latin America, Africa
and the Middle East.
 The European Regional Treasury Center (ERTC) was GM’s largest foreign exchange operation, covering European and Asia
Pacific FX exposures.
Review of Corporate Hedging Policy
General Motor’s overall foreign exchange risk management policy was established to meet three primary objectives:
1. Reduce cash flow and earnings volatility.
2. Minimize the management time and costs dedicated to global FX management.
3. Align FX management in a manner consistent with how GM operates its automotive business.
Passive Policy: Hedge 50% of Commercial (operating) Exposures

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GM policy also outlined what sorts of derivative instruments were to be used for hedging.
Commercial (operating) exposures A determination of “riskiness” was then made on regional basis, deciding which FX
exposures were significant enough to warrant hedging. This determination was governed by the following formula:
Implied risk = Regional motional exposure x Annual volatility
of relevant currency pair
Commercial exposures (capital expenditures) Unlike uncertain cash flows, planned investments (purchases of fixed assets or
equipment) that met either of the following two tests were hedged with forward contract using a 100% hedge ratio to the anticipated
payment date:
(i) amount in excess of $1 million, or
(ii) implied risk equivalent to at least 10% of the unit net worth.
Financial exposures Other certain cash flows, including loan repayment schedules and equity injections into affiliates were hedge
on a case-by-case basis.
Translation (balance sheet) exposures Translation exposures were not included under GM’s corporate hedging policy.
Accounting treatment One of the goals of GM’s hedging policy was to reduce earnings volatility. This goal was challenging given
that, under the prevailing accounting standards (FA 133), the forwards and options GM would use generally had to be marked-to-
market and the gains and losses flowed through the income statement

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Reporting Hedging activities were closely tracked and regularly reviewed within the Treasury Group.
Understanding the Choice of a Subsidiary’s Functional Currency
When GMS instead uses its local currency (euros) as its functional currency,
1. GM’s consolidated income statement will include a gain or loss on the changes in value, as measured in GMS’s local
currency of GMS’s non-local currency denominated asset/liability (GMS’s income statement will show the same).
2. GM’s balance sheet will show an adjustment to shareholders’ equity for the translation to U.S. dollars of GMS’s
assets/liabilities.
Implementing a Foreign Exchange Hedge
When a hedge position was being created or modified, Mercedes Michel handled transactions in both forward and options contracts.
Comparing Forward Contracts with Options
Specifically, it compared:
(1) the combination of the outright exposure plus a 50% hedge using forward contracts, with
(2) the combination of the outright exposure plus a 50% hedge using options.
Special Situations—the Argentinean Peso

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Credit analysts at Standard & Poor’s and Moody’s had downgraded Argentina to six and seven grades below investment grade,
respectively. GM Treasury’s Latin America experts believed the short-term probability of default had reached 40%. In the medium
term, the probability rose to 50% because Argentina had not addressed key issues such as trade liberalization, state reform, and
pension and healthcare reform.
Hedging the Peso Exposure
GM Argentina had already eliminated peso cash balances and transferred them in USD to the European Regional Treasury Center. It
was also considering the purchase of some materials locally in ARS for export to other entities on the region that would pay for them
in hard currency. GM-Argentina’s USD borrowings would certainly have to be addressed.
Understanding Competitive Exposures
Source of Competitive Exposure
This exposures was not created by GM’s inflows or outflows or how it chose to run its business. Rather, it was a result of competing
against companies with different home currencies. As a result, any depreciations in the yen lowered their relative cost structure as
compared to the U.S. and European auto manufacturers.
Measuring Competitive Exposures

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There was no projected receivable or payable and no capital investment or loan to be repaid, yet there was still a bottom-line impact
that stemmed from fluctuations in exchange rates.
The two most difficult factors to estimate were the consumer sales elasticity and the cross elasticity to GM sales.
A Place for Competitive Exposures in GM’s Corporate Hedging Policy?
Unlike the CAD and ARS deviations, the yen exposures was simply more difficult to measure. In the context of a passive policy,
implementing too many deviations might create a de facto active policy. What about the German car makers? Should euro exposures
be measured too? Either way, the first step was getting a handle on the magnitude of the yen exposure.
Conclusion
Feldstein had a great deal of thinking to do. None of the three cases—the CAD deviation, the ARS deviation, or the JPY deviation—
was a simple one. He was being asked to sign off on some very significant exposures, some in ways not necessarily contemplated
by GM’s hedging policy. It was important for him to understand not just what the policy permitted, but hwhat the economics of each
exposure were, and what was the best for GM as a consolidated global entity in each case.

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DISCUSSION
1. The Canadian Dollar
There are two assignments from Eric Feldsten, Treasurer and Vice President, Finance for GM Corp. regarding GM Canada’s
exposure to Canadian Dollar:
1. Feldsten needed a comparison of the income statement impact of a 75% versus a 50% hedge ratio. The proposal suggested
that the expected volatility of the CAD/USD exchange rate was plus-or-minus 3.1% around the 1.5780 exchange rate on the
date of the memo. Using this volatililty, Ostermann, FX and Commodities Manager, could do a sensitivity calculation with a
favourable scenario (gain due to FX movements) and an unfavourable scenario (loss due to FX movements) based on the
after-tax gain/loss impact from the projected CAD cash flow as well as from the CAD net monetary liability. Dividing this
amount by the 550 million shares GM had outstanding, Ostermann could determine how much the proposed deviation would
reduce EPS volatility. To simplify the calculation, Ostermann ignored the costs of hedging (such as option premiums).
2. Comparing forward contracts with options
Specifically, it compared : (1) the combination of the outright exposure plus a 50% hedge using forward contract, with (2) the
combination of the outright exposure plus a 50% hedge using options.

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First Analysis
GM Canada projected Cash Flow Exposure
Amount Sept. 30, 2001
(C$)
12 month C$ cash flow forecast - short 1,682.00
C$ Monetary net liability position - short 2,143.00
Total 3,825.00
Strategy I : 50% hedge ratio
3.1% drop Base case 3.1% up
Exchange rate CAD/USD 1.531 1.578 1.627
Hedged portion: 50% over 12 month C$ cash flow
forecast 841.00 532.95 532.95 532.95
Unhedged portion: 50% over 12 month C$ cash flow
forecast 841.00 549.47 532.95 516.93
Sub-total 1,082.43 1,065.91 1,049.88
Difference from existing exposure -
hedged/unhedged strategy (50% hedged) - negative
indicating unfavourable to GM 1,065.91 (16.52) - 16.02
Not hedged 1,400.15 1,358.05 1,317.21
Difference because of FX movements - negative
TOTAL (58.62) - 56.86 (1.76)
Probability (19.54) - 18.95 (0.59)
Shares outstanding 550
Unfavourable EPS impact (0.00107)
Strategy II : 75% hedge ratio on commercial
exposure (approximately 30% hedging ratio for
the balance sheet exposure)
forecast 1,261.50 799.43 799.43 799.43
forecast 420.50 274.74 266.48 258.46

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TOTAL (58.62) - 56.86 (1.76)
Probability (19.54) - 18.95 (0.59)
Strategy II : 75% hedge ratio on commercial
exposure (approximately 30% hedging ratio for
the balance sheet exposure)
forecast 1,261.50 799.43 799.43 799.43
forecast 420.50 274.74 266.48 258.46
Sub-total 1,074.17 1,065.91 1,057.89
Hedged portion: 30% 642.90 407.41 407.41 407.41
Unhedged portion: 70% 1,500.10 980.10 950.63 922.05
Sub-total 1,387.52 1,358.05 1,329.46
TOTAL (37.73) - 36.60
Probability (12.58) - 12.20 (0.38)

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Second Analysis
Exposure in CAD million 20
Forward
rate
1.4000 1.4500 1.5000 1.5500 1.5667 1.6000 1.6500 1.7000 1.7500 1.8000
Forward contracts - 50% hedged 50%
50% hedged 10 6.3828 6.3828 6.3828 6.3828 6.3828 6.3828 6.3828 6.3828 6.3828 6.3828
50% un-hedged 10 7.1429 6.8966 6.6667 6.4516 6.3828 6.2500 6.0606 5.8824 5.7143 5.5556
Total 13.5257 13.2794 13.0495 12.8345 12.7657 12.6328 12.4434 12.2652 12.0971 11.9384
Call Options contracts - 50% hedged
Notional hedge amount 6.382843
50% hedged 10 0.0000 0.0000 0.0000 0.0000 6.3828 6.3828 6.3828 6.3828 6.3828 6.3828
Premium cost (1.45% of notional hedge amount) 1.45% (0.0926) (0.0926) (0.0926) (0.0926) (0.0926) (0.0926) (0.0926) (0.0926) (0.0926) (0.0926)
50% un-hedged 10 7.1429 6.8966 6.6667 6.4516 6.3828 6.2500 6.0606 5.8824 5.7143 5.5556
Total 7.0503 6.8040 6.5741 6.3591 12.6731 12.5403 12.3509 12.1726 12.0046 11.8458
Difference forward - options contracts 6.4754 6.4754 6.4754 6.4754 0.0926 0.0926 0.0926 0.0926 0.0926 0.0926
Exchange Rate (CAD/USD)
From the above analysis, it appears that call options looks more attractive then forward contracts, and more flexible.

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2. Special Situations – the Argentinean Peso
Background of issue:
Argentina government, in order to cure rampant inflation, has exercised control over foreign currency exchange and maintained a
peg to the U.S. Dollar at USD 1 : ARS 1. With a debt-to-GDP ratio of 45% and $16.5 billion coming due in 2002, the ”zero-deficit” law
passed by the Senate in 2001 put Argentina at serious risk of defaulting on its debt. A default would undoubtedly be accompanied by
a massive devaluation. The GM treasury analysts expected a potential devaluation of the peso against the dollar from 1:1 to 2:1.
Issue :
1. Local currency equivalent of USD borrowings by GM Argentina (a local currency functional subsidiary) would grow, putting
financial pressure on the subsidiary. In fact, the $300 million USD net liability position would double in peso terms to an ARS
600 million liability. There would be a consequent ARS 300 million adverse income statement impact, as reflected in the loss
on foreign exchange, for the subsidiary.
2. there would be a substantial translation loss on GM Argentina’s ARS denominated net assets when these net assets were
consolidated in USD with all other assets of GM Worldwide.

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GM Argentina Balance Sheet, Monetary Assets and Liabilities by Currency
A: 30 September 2001
ARS Monetary Assets ARS Monetary Liabilities
Scrap incentive owned by government 45.80 Payables to local suppliers 24.10
Interest subsidy owned by government 3.20 Provisions to local suppliers 11.30
VAT credit and other tax owed by government 130.60 ARS loan (VAT financing) 13.70
Receivable (tax credit reimbursement) 2.70 Other provisions 9.80
Other 7.80 Tax payable 2.00
Total ARS Monetary Assets 190.10 Total ARS Monetary Liabilities 60.90
USD Monetary Assets USD Monetary Liabilities
Cash 2.50 Accounts payable 224.50
Receivables 20.50 Loans 101.30
Total USD Monetary Assets 23.00 Total USD Monetary Liabilities 325.80
Total Monetary Assets 213.10 Total Monetary Liabilities 386.70
ARS net property, plant and equipment
(assumption) 350.00 Stockholders' Equity 176.40
Common stock at 1:1 100.00
Retained earnings 76.40
Total Assets 563.10 Total Liabilities and Equity 563.10
First Problem faced by GM Argentina :
Net USD Monetary Liabilities (325.80 - 23.00) 302.80
With likely devaluation of Peso to 2:1
Estimated loss on foreign exchange flowed
through Statement of Income 302.80
Implication : Stockholders' Equity
will become negative (126.40)
Second Problem faced by GM Worldwide when
consolidating GM Argentina
Assuming using September 30, 2001 figures
GM Argentina Balance Sheet (ARS currency)

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With likely devaluation of Peso to 2:1
Estimated loss on foreign exchange flowed
through Statement of Income 302.80
Implication : Stockholders' Equity
will become negative (126.40)
Second Problem faced by GM Worldwide when
consolidating GM Argentina
Assuming using September 30, 2001 figures
USD Monetary Assets translated to ARS using 2:1
USD Monetary Liabilities
translated to ARS using 2:1
(assumption) 350.00 Stockholders' Equity (126.40)
Total Liabilities in USD Dollar
(divided by 2) 356.25
Common stock (assumption) 100.00
Retained earnings 76.40
Translation loss adjustment (239.60)
Total Stockholders' Equity (63.20)
Total Assets in USD Dollar (ARS balance/2) 293.05 Total Assets and Liabilities 293.05
Translated GM Argentina Balance Sheet

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From the above translated GM Argentina Balance Sheet in USD Dollar using Current Method, it is obvious that the stockholder’s
equity of GM Argentina will suffer negative worth after the devaluation of ARS towards US Dollar from 1:1 to 2:1. Before devaluation,
the equity indicates positive ARS176.4 and after devaluation, it reduces to negative ARS126.40. From the GM Worldwide
consolidation level, there would be a negative impact to EPS after taking into effect of translation adjustment loss totaling
US$239.60.
Management of an USD Accounts Payable -
assuming falling due within 90 days
Hedging strategy:
1 Remain unhedged
2 Forward market hedge
3 Money Market Hedge
US$224.50/(1 + (0.05 x 90/360)) USD
Principal 224.50
USD investment rate per year 5%
USD needed today 221.73
ARS needed at the current spot rate ARS1/US$1 221.73
ARS 221.73 x [1 + (0.12 x 90/360)]
GM Worldwide WACC 12%
Total cost of the money market hedge in ARS 228.38
To implement a money market hedge, GM Argentina would exchange ARS spot and invest them for 90 days in a US Dollar
interest-bearing account. The principal and interest in US Dollar at the end of 90-day period would be used to pay the ARS
accounts payable
In order to ensure that the principal and interest exactly equal the US$224.50 due in 90 days, GM Argentina would discount
the US$224.50 by the US$ investment interest rate of 5% (assumption) for 90 days in order to determine the US$ needed
today:
Finally, in order to compare the money market hedge outcome with the other hedging alternatives, the ARS 221.73 cost today
must be carried forward 90 days to the same future date as the other hedge choices. If the current dollar cost is carried
forward at GM Worldwide WACC of 12% (assumption), the total cost of the money market hedge is
This cost is lower than the forward hedge and therefore attactive
GM Argentina could wait 90 days, exchange dollars for ARS at that time and make its payment. The amount to be paid is
uncertain and the spot exchange rate in 90 days could be very different from that expected. Assuming unbiased expectation
prevails, the forward rate for 6-month is used to reflect expected spot rate for 90 days = ARS 1.350 to US$1, this strategy will
cost ARS 303.075.
GM Argentina could buy US$ 224.50 forward, locking in a rate of ARS 1.45 to US$ 1, and total ARS cost of ARS 325.525. This
amount is ARS 22.45 higher than the expected cost of remaining unhedged and therefore clearly preferable to the first
alternative. It was mentioned that this strategy will cost US$18.2mio for three-month forward, or resulting in total cost of ARS
343.725

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ARS 221.73 x [1 + (0.12 x 90/360)]
GM Worldwide WACC 12%
Total cost of the money market hedge in ARS 228.38
4 Option hedge
US$ 224.50 x 0.015 x ARS1.40/USD 4.71
Strike price ARS to USD 1.40
Premium rate 1.50%
4.855935
Exercise call option (US$ 224.50 x ARS 1.40/US$)
Strike price for call option 1.40 ARS 314.30
Call option premium (carried forward 90 days) 4.86
Total maximum expense of call option hedge 319.16
GM Argentina could cover its US$224.50 accounts payable by purchasing a call option on US$224.50. Assuming, a 90-day
(December 2001) call option on US Dollar with a near at-the-money strike price of ARS1.40/USD would cost 1.5% (premium),
or :
This premium, regardless of whether the call option is exercised, will be paid up front. Its value carried forward 90 days at the
WACC of 12%, would raise its end-of-period cost to ARS 4.86.
If the spot rate in 90 days is less than ARS 1.40/US$, the option would be allowed to expire and the US$224.50 for the
payable purchased on the spot rate. The total cost of the call option hedge if the option is not exercised is theoritically smaller
than any other alternative (with the exception of remaining unhedged, because the option premium is still paid and lost.
If the spot rate in 90 days exceeds ARS 1.40/US$, the call option would be exercised. The total cost of the call option hedge if
exercised is as follows:
Finally, in order to compare the money market hedge outcome with the other hedging alternatives, the ARS 221.73 cost today
must be carried forward 90 days to the same future date as the other hedge choices. If the current dollar cost is carried
forward at GM Worldwide WACC of 12% (assumption), the total cost of the money market hedge is
This cost is lower than the forward hedge and therefore attactive

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Ending spot
exchange
rate
(ARS/US$)
Strategy 1 Strategy 2 Strategy 3 Strategy 4
Unhedged
Forward
Market
Hedge
Money
Market
Hedge
Option
Hedge
224.5
1.00 224.50 343.73 228.38 4.86
1.05 235.73 343.73 228.38 4.86
1.10 246.95 343.73 228.38 4.86
1.15 258.18 343.73 228.38 4.86
1.20 269.40 343.73 228.38 4.86
1.25 280.63 343.73 228.38 4.86
1.30 291.85 343.73 228.38 4.86
1.35 303.08 343.73 228.38 4.86
1.40 314.30 343.73 228.38 4.86
1.45 325.53 343.73 228.38 319.16
1.50 336.75 343.73 228.38 319.16
1.55 347.98 343.73 228.38 319.16
1.60 359.20 343.73 228.38 319.16
1.65 370.43 343.73 228.38 319.16
1.70 381.65 343.73 228.38 319.16
1.75 392.88 343.73 228.38 319.16
1.80 404.10 343.73 228.38 319.16
1.85 415.33 343.73 228.38 319.16
1.90 426.55 343.73 228.38 319.16
1.95 437.78 343.73 228.38 319.16
2.00 449.00 343.73 228.38 319.16
Cost in ARS to pay US$ 224.50

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The four hedging methods of managing a US$224.50 accounts payable for GM Argentina are summarized in below Exhibit. The
costs of the forward hedge and money market hedge are certain. The cost of using the call option hedge is calculated as a
maximum, and the cost of remaining unhedged is highly uncertain.

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For US Dollar-denominated loans totaling US$101.30, the Company could consider a number of strategies, assuming the loans
payable to GM North America as a parent:
1. Replace US$-denominated loans to local currency ARS loans. This strategy could be actioned by:
 having GM Argentina to obtain the same amount of ARS224.50 from local Argentine banks. However, perhaps it won’t be
easy to get local Argentina banks to finance the refinancing from US$ to ARS, and if there is, the interest rate charged will
be too high to accept.
 having GM Argentina or through GM North America to use currency swaps.
 Using parallel loans to hedge exchange rate risk. However, considering timeline, perhaps, this is not a good option, as it
will take time to find a good Argentina company or party that is willing to provide simultaneous loans with an agreement to
repay at a specified point in the future.
 Having GM North America to be willing to convert the US$-denominated loans to be payable in ARS-based loans using
current spot rate of 1:1.
2. Other strategy to explore is to have intracompany leads and lags which is more feasible in this case.
3. Balance sheet hedge approach by creating US$-denominated receivable, for example, by having GM Argentina to do exports
to other GM affiliates, which could bring in revenues and creating receivables in US Dollar that will match the US$-
denominated accounts payable and loans.

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Translation exposure
Translation exposure for example, as faced by GM Argentina, is typically mitigated by using balance sheet hedge. A balance sheet
hedge requires an equal amount of exposed foreign currency assets and liabilities on GM’s consolidated balance sheet. This balance
sheet hedge is justified since :
1. GM Argentina is using the local currency as the functional currency.
2. GM Argentina is operating in a hyperinflationary environment
In practice, some MNCs have attempted to hedge translation exposure in the forward market. Such action amounts to speculating in
the forward market in the hope that a cash profit will be realized to offset the non-cash loss from translation. Success of this strategy
depends on a precise prediction of future exchange rates, for such a hedge will not work over a range of possible future future spot
rates. In addition, such a hedge will increase the tax burden, since the profit from the forward “hedge” (i.e., speculation) is taxable,
but the translation loss does not reduce taxable income. Also, it is still highly controversial for a firm to expend resources and acquire
hedging position with forwards and swaps to hedge accounting results.
Assuming that balance sheet hedge is acceptable to GM management, GM management could either :
1. increase exposed ARS assets without simultaneously increasing ARS liabilities, or
2. reduce ARS liabilities without simultaneously reducing ARS assets.

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USD Monetary Assets translated to ARS using 2:1
USD Monetary Liabilities
translated to ARS using 2:1
(assumption) 350.00 Stockholders' Equity (126.40)
Net exposed liabilities in ARS 126.40
Divided by exchange rate, ARS/USD 1.00
Net exposed liabilities in USD 126.40
times amount of devaluation 200%
Expected translation loss under Current Method 252.80
Conclusion : the final hedging choice by GM management will depend on the confidence of ARS exchange rate expectations, and
GM management’s willingness to bear risk. The money market hedge, if feasible in Argentina market, appears the preferred
alternative. Otherwise, option hedge will be the second choice.

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3. COMPETITIVE EXPOSURE FROM JAPANESE AUTOMAKERS RESULTING FROM DEPRECIATION OF JAPANESE
YEN
Summary of Data Collected
A 5% price increase could be expected to lower unit sales by around 10%
A consequent annual impact on GM's Income Statement could then be valued as a perpetuity at a 20% discount rate
Average Japanese car had between 20% and 40% Japanese content
A reasonable etimate of what the Japanese automakers might give away in terms of added incentives or lower sticker prices would be between 15% and 45% of the cost savings
Any market share losses to Japanese automakers would be shared equally among and entirely by the Big Three in Detroit.
A rough calculation around a 20% yen devaluation would capture an upper bound of the likely exposure.
Japanese automakers derived 56% and 43% of their revenues from the U.S Market in 1999 and 2000, respectively
In recent year, they sold 4.1 millions units in the United States
Equity analysts had estimated that the yen appreciation from 117 to 107 during the first half of 2000 had reduced Japanese automakers's combined global operating profits by $4 billion. Or reverse, for
every 1 yen depreciaton against the dollar, Japanese competitors' collective operating profit grew by more than US$400 million
Rough estimate from research reports suggested that the Japanese firms were unprofitable when the yen was stronger than110 to the dollar and profitable at 120 or more yen to the dollar

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Analysis
Chain of events Data Collected Assumption Base Case Case 1 Case 2
Assumption
for Base Case
Pass through
rate =30%
Pass-through
rate
Pass-through
rate
15% 45%
(1) A depreciation in the yen lead to 100 Exchange rate (Yen/USD) 100 100 100
(2) additional gross margin for Japanese
automakers, who
For every 1 yen depreciation, Japanese
competitors' collective profit grew by more
US$400 million 400
1 Yen depreciation, cost
savings (in million dollar) in
terms of operating profit 400 400 400
(3) passed along some of this benefit to
consumers in the form of lower prices, and
Average Japanese content 20-40% and pass-
through rate 15%-45% of the cost savings. 30%
pass-through rate on cost
savings : (in million US$) 120 60 180
(4) as a result of lower prices, the Japanese
automakers gained market share in the U.S.,
which
Cross elasticity to GM sales : a 5% price increase
to lower unit sales by around 10%. Japanese
automakers derived 56% and 43% of their
revenues from the U.S. market in 1999 and 2000.
Average incentive per unit in the US : Honda 664,
Toyota 725 50%
Cost saving impact of
Japanese automakers to
gaining bigger market
share in US market - in
million US Dollar 60 30 90
(5) ate into unit sales at GM, which
any market share losses to Japanese automakers
be shared equally by the Big Three 3 Shared equally by three 20 10 30
(6) lowered GM's profits, which
Average net income to net sales of GM for the
past three years 2.6% (see Exhibit 1 in the Case) 2.60%
Impact to net income (on
average 2.6% to net sales) 0.52 0.26 0.78
(7) reduced GM's market value
Discount rate on income statement negative
impact = 20% at perpetuity 20%
Impact to GM's market
value 2.6 1.3 3.9
From the above analysis, it appears that for every 1 Yen depreciation against the US dollar, GM will suffer the decline in its market
value ranging from US$1.3 billion to US$3.9 billion.

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As noted in the Case Study that GM should place its estimated competitive exposure in the context of GM’s overall yen exposure.
This included :
1. a commercial exposure based on forecasted receivables and payables of US$900 million
2. an investment exposure resulting from equity stakes in several Japanese companies
Affiliate
Affiliate
Exposure
Long/(Short)
($ billions)
GM Ownership Stake
Fuji (1.50) 20%
Isuzu (1.02) 49%
Suzuki (0.09) 20%
3. a financing exposure through a yen-denominated loan, totaling US$500 million of outstanding bond.
In addition to the GM management’s efforts to lobby US Government to have a G to G discussion with the Japanese government in
order to achieve a competitive exchange rate between Japanese Yen and US Dollar, GM management could consider diversifying its
operations (and financing as well) in near future internationally, which will preposition GM management both to recognize
disequilibrium when it occurs and to react competitively. Although the disequilibrium may have been unpredictable, GM management
can often recognize its symptoms as soon as they occur.

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Recognizing a temporary change in worldwide competitive conditions permits GM management to make changes in operating
strategies. Management might make marginal shifts in sourcing raw materials, components, or finished products. If spare capacity
exists, production runs can be lengthened in one country and reduced in another. The marketing effort can be strengthened in export
markets where the firm’s products have become more price-competitive because of the disequilibrium condition.
Even if management does not actively distort normal operations when exchange rates change, the firm should experience some
beneficial portfolio effects. The variability of its cash flows is probably reduced by international diversification of its producitons,
sourching, and sales (and financing) beause exchange rate changes under disequilibrium conditions are likely to increase the firm’s
competitiveness in some markets while reducing it in others.
~~~~~~ ####### ~~~~~~

Page 26
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