Executive Summary Being one of the largest automakers in the world, General Motors (GM) undertakes its manufacturing operations in over 30 countries with vehicles being sold in over 200 countries. Through undertaking its international operations it also subjects itself to various types of foreign exchange exposures due to fluctuations in the values of currencies; to manage this problem it has adopted a passive hedging policy and aims to reduce the impact of foreign exchange exposures on the business. The first part of this report outlines the various types of foreign exchange exposures that GM can subject itself to and also outlines what methods can be used to reduce the risk associated with changes in the value of currencies; the …show more content…
Using Financial Instruments to Hedge Hedging through the use of financial instruments is whereby instruments such as forwards, options and money markets are used to manage the risk of foreign exchange exposure. • Forward Hedges are where a contractual obligation exists regarding the buying or selling of a currency at a specified fixed future rate on a specified future date. It requires a source of funds (Eiteman, Stonehill and Moffett, 2010). • Option Hedges are a right not an obligation to buy or sell a specified currency at a specific rate on a specified future date. It allows for speculation on the upside while still limiting the loss (Eiteman, Stonehill and Moffett, 2010). • Money Market Hedges is another method, this contract is a loan agreement whereby a firm borrows in one currency and exchanges the proceeds in another currency (Eiteman, Stonehill and Moffett, 2010). Natural Hedging This type of hedging is whereby foreign exchange exposures in outflows of cash are offset by inflows of cash through matching of transactions (i.e. Revenues and Expenses). Natural hedging focuses on operating cash flows; for example a receivable is offset by a payable in the same currency without the use of financial instruments, this however requires consideration of synchronising values of the cash flow and timing of the cash flows (Eiteman, Stonehill and Moffett, 2010). Strategic Decision making by MNE’s There are various factors
The Balance of Payments in India mainly relies on services exports, remittances and the course capital flows, both foreign direct investments (FDI) and FII. It is very essential that all market participants, such as banks and other intermediaries be provided with the wherewithal so that they can undertake a risk management in a way that is scientific. One of the ways to access domestic, foreign exchange markets is to hedge on the underlying foreign exchange exposures. In addition, the facilities that are available as the booking of forward contracts were included in the domestic forex market in order to evolve and acquire volumes and depth (Sumanth, 2012). Some of the newer hedging instruments have put in place swaps and options in the
2) Minimize the cost associated with the foreign exchange risk management strategy, i.e. the management and hedging costs
Hedging is a significant measure of financial risk management. Since the 1970s, the increasing number of powerful companies started to control the risk of the exchange rate, the interest rate and commodity by using financial derivatives. ISDA (2013) based on the Global 500 Annual Report 2012 survey found that 88 percent of companies use foreign exchange derivatives. Modigliani & Miller (1958) believed that if the financial markets were under perfect conditions, for instance, there was no agency costs, asymmetric information, taxes and transaction costs, hedging would not increase the company 's value because investors can hedge by themselves. However, a large number of practical studies have shown that hedging is beneficial
Currency exposures assume many forms: they can be assets or liabilities; current or committed; contracted or merely forecast; they can be for trade, investment or balance sheet purposes. Cases of currency exposure can emerge at any point along the value chain, with various repercussions. Each requires a transfer of funds, and for each the rate of exchange is uncertain. Examples of different types of currency exposures are presented below.
General Motors Corporation, the world’s largest automaker, has an extensive global outreach, which places the firm in competition with automakers worldwide, and subjects itself to significant exchange rate exposure. In particular, despite most of its revenues and production being derived from North America, depreciating yen rates pose problems for the firm indirectly through economic exposure. While GM possesses ‘passive’ hedging strategies for balance sheet and income statement exposures, management has not yet quantified or recognized solutions to possible losses from the indirect competitive exposure it now shared with Japanese automakers in the U.S import
There are lots of methods to solve the changes in foreign currency and interest rates issue, however, derivative financial instruments are the major tunes Nike enterprise has used to tackle this issue. Despite the fact that this approach does not wipe out comprehensively the risk of foreign exchange, Nike enterprise still utilize it to minimize or delay the negative consequences. Specifically, the derivative financial instruments comprise embedded derivatives, interest rate swap, and foreign exchange forwards and options contracts (Nike annual report, 2014).
By paying an option premium, Jaguar could reserve the right but not bear the obligation to exercise the option –based on favorable or unfavorable currency levels.
Forward contract. Lock in an exchange rate with the bank until a certain future date, with currency projections against the spot rate though. In this case had an option to have Forward contracts, which allow Nodal fixed exchange rates in the future at no charge, the bank may impose a fee
Given the nature of its business, Jaguar is faced with three types of exchange rate exposure (1) Transaction, (2) Translation and (3) Economic . Transaction exposures arise whenever the firm commits (or is contractually obligated) to make or receive a payment at a future date denominated in a foreign currency. Translation exposures arise from accounting based changes in consolidated financial statements caused by a change in exchange rates. In this case we primarily focus on the Economic exposure -also known as Operating exposure or Competitive exposure- of Jaguar.
But, even though the possibility of winning exists, the company is exposed to a greater risk if it does not hedge. Moreover, the policy of the company is to ensure against the risk, not to speculate on the foreign exchange market.
What is hedging? Hedging is a strategy used to protect risks posed by worldwide currency fluctuations. One hedges the currency risk by contracting to sell foreign currency in the future, at the current exchange rate (Fries). If fund managers think the dollar is going to be stronger when they are ready to change the foreign currency back into American dollars, then they take out a foreign futures contract (a hedge). Thus, they lock in the exchange rate beforehand, so that they will not lose profits gained from holding devalued foreign currency (Hedging, 1999). If the manager guesses correctly, he will boost the fund 's overall return because the profits will be worth even more when they are exchanged into American dollars.
Most firms hedge at least some of their risks. Hedging can take two basic forms—namely, natural hedging and hedging by means of derivative instruments. The use of derivatives as hedges has expanded greatly in recent years.
Hedging can be defined as a risk management mechanism or strategy which is used to prevent the chances of incurring losses which arise as a result of fall in prices commodities or currencies. It is a technique which is majorly used by the investors in protecting their capital against the effects of the economic situations such as inflation whereby the investors invests in the high yield financial instruments or take a position to cushion them against such effects (Investopedia, 2012).
There are four main methods for hedging the currency exposure of DEM; Forward, Money Market, Futures and Currency Options. Each alternative has different timing of cash flows and costs.