Can you please do the foreign exchange case at Ford and the questions relating to the case on the course outline?
9-205-095 R E V : J A N U A R Y 9 , 2 0 0 6 ________________________________________________________________________________________________________________ Professor Mihir A. Desai and Research Associate Mark F. Veblen prepared the original version of this case, “Foreign Exchange Hedging Strategies at General Motors,” HBS Case No. 204-024. This version was prepared by Professor Mihir A. Desai.and Research Associate Mark F. Veblen. HBS cases are developed solely as the basis for class discussion. Certain figures and details have been disguised and do not reflect the actual operations of General Motors Corp. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2005 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School. M I H I R A . D E S A I M A R K F . V E B L E N Foreign Exchange Hedging Strategies at General Motors: Transactional and Translational Exposures In September of 2001, Eric Feldstein, Treasurer and Vice President, Finance for General Motors Corporation (GM) paid little attention to his unobstructed view of Central Park from his office far above the Manhattan traffic. He was preoccupied with particular foreign currency exposures that required significant risk management decisions. An immediate priority was a decision on what to do about GM’s billion dollar exposure to the Canadian dollar. Another pressing issue was GM’s exposure to the Argentinean peso in light of the expected devaluation in the months ahead.1 Feldstein and his treasury team were responsible for all of GM’s monetary transactions and for managing the myriad risks associated with the timing of those transactions. They handled everything from investing excess cash from vehicle sales receipts to hedging currency risks when a foreign subsidiary like Opel Austria announced it would remit a dividend to the worldwide parent company. The GM Treasury program invested heavily in its people, rotating them through functional positions and offices around the world, developing their skills and experience. The unit continued to produce individuals who went on to senior finance positions with GM subsidiaries or elsewhere within the GM organization or left for senior roles at other major U.S. companies. As GM expanded around the world, the magnitude of its exposures to foreign currencies grew. Because exchange rate swings created gains and losses that flowed through GM’s reported income statement, it was essential from a planning and management perspective to understand GM’s foreign exchange flows and to manage the earnings and cash flow volatility they imposed on GM. Feldstein constantly followed news on volatile political situations around the world and kept abreast of macroeconomic trends that might affect GM’s finances. GM senior executives had implemented a number of formal policies with respect to foreign exchange risk management and hedging procedures. These policies guided the vast majority of treasury operations, but on occasion situations arose that required special attention and possibly a deviation from the stated policy. Feldstein, who had the authority to sign off on policy deviations, 1 The economic consequences of movements in the Japanese yen were also of significant concern and are the subject of “Foreign Exchange Hedging Strategies at General Motors: Competitive Exposures,” HBS Case No. 205-096 (Boston: Harvard Business School Publishing, 2005). 205-095 Foreign Exchange Hedging Strategies at General Motors: Transactional and Translational Exposures 2 was currently reviewing such proposals for the Canadian dollar (CAD) and Argentinean peso (ARS). In his analysis, Feldstein paid particular attention to the transactional and translational consequences of the CAD exposure, the choice of instruments he could use to implement any deviations and possible responses to the worsening situation in Argentina. Overview of General Motors and its Treasury Operations General Motors2 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 2000, it generated earnings of $4.4 billion on sales of $184.6 billion (see Exhibit 1 for GM’s consolidated income statement). 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 Motors 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 (see Exhibit 2 and Exhibit 3), 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 market share in Latin America was 20% and in Europe had reached 10% (20% if Fiat’s figures were included).3 Increasing market share in Asia, which stood at 4%, was a major strategic objective for GM. General Motors Treasurer’s Office GM’s Treasurer’s Office performed a full range of corporate treasury functions from its head office in New York and through additional locations in Brussels, Singapore and Detroit. The organizational structure shown in Exhibit 4 demonstrates the nature and extent of those activities. One of the key functions of the Treasurer’s Office was financial risk management. This included management of not only market risk (foreign exchange, interest rate and commodities exposures) but also counterparty, corporate and operational risk. Exhibit 5 outlines the components of this function and demonstrates the high degree of centralization in approach. All of GM’s financial risk management activities were subject to oversight by the Risk Management Committee, which was composed of six of GM’s most senior executives including 2 Statistics drawn from General Motors, 2001 Annual Report (Detroit: General Motors, 2002) and General Motors, December 31, 2001 10-K (Detroit: General Motors, 2002). 3 General Motors owned 20% of Fiat, and Fiat held an option to put the remaining 80% to GM. Foreign Exchange Hedging Strategies at General Motors: Transactional and Translational Exposures 205-095 3 Feldstein.4 The committee met quarterly to review the performance of GM’s financial risk management strategies and to set treasury policy for GM and its subsidiaries. Treasury policy included evaluating the parameters and benchmarks for managing market risks, determining criteria for assessing counterparty credit risk, determining thresholds for property and liability insurance coverage, as well as reviewing internal control aspects of operating policies and procedures. GM’s formal, company-wide policies contained not only broad principles, but also detailed execution procedures such as, in the case of foreign exchange risk management, the types of instruments to be used and the appropriate time horizons.5 At its meetings the committee also discussed any special topics that needed to be addressed. Such special topics often included precisely the deviations from usual policy Feldstein was currently considering. 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 FX hedging activities were segregated in this way on the principle that there should be some geographic correspondence between where a business unit was actually managed and where treasury for that business was controlled. At the same time, though, it was considered desirable to reap the benefits of pooling exposures across groups. In a sense, the goal was to match treasury management to the footprint of the business. Having local market knowledge and a trading center in both the European and U.S. time zones was also very helpful, because GM was active in each of the major foreign exchange markets. In managing the FX exposures, both the Domestic Finance group and the ERTC worked closely with other groups within Treasury that had the primary responsibility of providing strategic support to GM entities within that region. These groups were also the global coordinators for intercompany loans, moved cash around the world to finance overseas mergers and acquisitions activities, and managed dividend repatriations. Review of Corporate Hedging Policy General Motors’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, and (3) align FX management in a manner consistent with how GM operates its automotive business. The first constituted a conscious decision to hedge cash flows (transaction exposures6) only and ignore balance sheet exposures (translation