Hedging Strategy for GM to manage competitive currency exposure

Quantifying and Managing Competitive Exposure at General Motors

Group Project For International Finance Submitted to Prof. T.S. Srinivasan Group 11, Section B PGP27198/ Abhineet Gaurav PGP27209/Ashish Khanna PGP27210/ Atul Kr. Singh PGP27230/ Prashant Pawar PGP27243/ Rakesh Jangili FPM13003/Prateek Sharma PGp27006/ Aniruddh Dixit 1

Table of Contents 1.

Executive Summary ............................................................................................................................... 3

2.

Competitive Currency exposure at GM (2001: Using Case Info) .......................................................... 4 2.1.1

Recent Performance ............................................................................................................. 5

2.2

Automobile Market in USA ........................................................................................................... 5

2.3

Competitive Exposure Mechanism ............................................................................................... 7

2.4

Yen Exposure Quantified............................................................................................................... 7

3.

Approaches to Manage GM's Competitive Exposure ........................................................................... 9

4.

GM’s competitive Yen exposure (1993 to 2005) ................................................................................ 12

5.

4.1

GM’s US Car Sales Exposure ....................................................................................................... 13

4.2

GM’s Market Share Exposure ..................................................................................................... 14

4.3

GM’s Net Income Exposure ........................................................................................................ 15

4.4

Implication of result on hedging strategy ................................................................................... 16

“New” GM’s Competitive Exposure .................................................................................................... 18 5.1

Issues in measuring quantifying exposure using regression....................................................... 19

5.2

GM’s Unit Sales Exposure (Worldwide) ...................................................................................... 20

5.3

GM’s Auto Revenue Exposure (Worldwide) ............................................................................... 21

5.4

Moving to a net income like exposure........................................................................................ 22

5.5

Hedging the resulting exposure .................................................................................................. 23

6.

Conclusion ........................................................................................................................................... 25

7.

Attachements ...................................................................................................................................... 26

8.

Sources Used ....................................................................................................................................... 26

2

1.

Executive Summary

In this report we have tried to quantify General Motors’ (GM) Competitive exposure against various currencies. For this we have adopted a three pronged approach where in one part we have described the competitive exposure against Yen faced by GM till the period described in the case (2001). In next two Sections, we have tried to quantify the competitive exposure faced by GM till 2005 and the exposure faced by GM currently. The 2nd section has been kept to 2005 as years 2006, 2007 and 2008 were years of heavy loses for GM and we wanted to keep those extra-ordinary data points out of analysis. To quantify GM’s exposure to yen we have regressed its financial results with Yen Index. In third section, we have tried to quantify “New” GM’s Competitive exposure. Currently GM seems to be affected by both Won and Yen, we have tried to capture the relevant risk by regressing the financials with Yen and Won indices respectively. The financial data for GM has been collected from the website www.sec.gov, while the Yen dollar and Won dollar index have been downloaded from the St. Louis Fed website (www.research.stlouisfed.org/fred2). At end of every section we have suggested ways by which GM can contain these exposures. However, to take hedging decisions in practical situations one would require greater information like what is the current exposure of GM in terms of translation and transaction risks in various currencies. Then one would need the correlation between those currencies and then one can net out the resultant exposure from competitive exposure to get the actual exposure value which needs to be hedged. Competitive exposure can change over time in terms of currencies and amount so any hedging policies must be made keeping this in mind. This is visible in case of GM which now seems exposed both to Korean Won and Japanese Yen, while in beginning of the millennium it was affected only by Yen.

3

2.

Competitive Currency exposure at GM (2001: Using Case Info)

In 2001 General Motors was world’s leading automaker. At 8.5 million vehicles, GM enjoyed a market share of 15% and an annual sales of $184.6 billion over which it made earnings of $4.4 billion. Besides its automotive division which was responsible for manufacturing and selling SUVs, sedans etc., the company had automobile financing and division which had annual sales of $24 billion in 2001 and earnings of $1.6 billion1. The company sold its cars in 200 countries and had its manufacturing operations in 30 countries. Due to its international operations (it receives more than 25% of its sales from outside US), it had had organized its main automotive division into four geographic divisions: a) GM North America b) GM Europe c) GM Asia Pacific and d) GM Latin America/Africa/Middle East.

GM Breakdown of Net Property, 2000 Latin

GM Breakdown of Sales, Auto 2001 Componen Latin Asia America, Pacific Africa, 2% Middle East 4% Europe 15%

Hughes 5%

America 4%

ts, Others 2%

Others 2%

Europe 19%

North America 72%

North America 75%

GM’s portfolio of vehicles included popular sedans such as Opel, Saab, Buick, Chevrolet, Cadillac etc. In United States, its major market, GM faced competition from besides Ford, Chrysler and BMW and a host of Japanese automakers such as Toyota, Nisan, Honda, Mazda and Mitsubishi.

1

General Motors, December 31, 2000 10-K

4

2.1.1 Recent Performance

GM Financial Performance 190000

GM New Registrations as a % of Total

6.00% 5.00%

180000

4.00%

170000

3.00%

160000

2.00%

150000

1.00%

140000

40% Total net sales and revenue (in $ millions)

30% 20% 10%

Operating Margin

0%

0.00%

In US In Canada and Mexico In Other countries

199819992000

Due to increased competition, GM’s market share was slowly declining. As the following graph shows, new registrations for GM as % of total new registrations was gradually falling Due to its sizeable foreign operations, the company faced significant amount of currency risk. The company estimated that liability due to instruments with foreign currency exposure was $13 billion in 2000. GM employed a variety of financial derivative products such as forward contracts, swaps and options to hedge against foreign currency related losses. For transactions denominated in foreign currencies, GM hedges forecasted and firm commitments upto 1 year. For commodities (such as aluminium and other non-ferrous metals used in automobile manufacturing), it hedges exposure up to 6 years. The company suffered losses of $100 million and $162 million in transaction and translation losses in 2000 and 1999 respectively. 2.2 AUTOMOBILE MARKET IN USA The automobile market in USA consists was a well-developed mature market during 2001. There were around 24 companies who were competing in the US market. Major products were cars, trucks and buses. GM, Ford, Chrysler and PACCAR were the major American companies in the automobile industry. They operated on a global scale and had manufacturing units outside USA also. Together they captured about 63% of market share in US. They faced stiff 5

competition from outside players. Their market share declined to 63% in 2001 from 72.4% in 19942. This was a time when the Japanese, Korean and German companies were capturing the lost market share of these American firms. As can be seen in the Figure below, the market share of Japanese companies rose from 22.84% to 26.29% during the same period (1994-2001). Even the German car makers share rose from 2.15% to 5.62%. The major Japanese players were Honda, Nissan and Toyota each having a market share of 6.91%, 4.03% and 9.97% in 2001. The competitions from foreign firms were also unpredictable because of the exchange rate fluctuation and offering competitive advantage to some. The incentives given to customer per vehicle were on average around 1593. GM was already giving an incentive higher than this whereas Toyota and Honda were giving around one-third of what GM was giving. This shows that the GM was running its business on pretty narrow margins. The fear of yen depreciating was a critical problem for US automakers in general. They also had to be wary of German and Korean car manufacturers.

Market Share of Automobile companies US Market Market Share (Percentage)

80

70

1994

60

1995

50

1996

40

1997 1998

30

1999 20

2000

10

2001

0 American Total 2

Germany Total

Japan Total

http://wardsauto.com/keydata/historical/UsaSa28summary

6

South Korea Total

2.3 COMPETITIVE EXPOSURE MECHANISM

Depreciation In Yen Additional Gross Margin for Japanese Manufacturers Lower Prices by Japanese Manufacturers Gaining of Market Share by Japanese companies Reduction in GM's Unit Sales and Margins Loss in GM's Net Income (Competitive Exposure) 2.4 YEN EXPOSURE QUANTIFIED General Motors Yen Exposure can be categorized into following categories:

1. Commercial Exposure: This is the exposure that arises because of sales and purchase happening in foreign currency. Based on receivables and payables forecasted, GM was estimated to have 900 million USD in Yen exposure. 2. Affiliate Investment Exposure: GM had significant investments in three Japanese companies: Fuji, Isuzu and Suzuki. Due to this it was exposed to Yen exposure. Any depreciation in Yen would therefore affect GM’s value of investments. 3. Borrowings in Yen – GM had recently completed a Yen bond issue. It therefore had approximately $500 million worth of bonds outstanding and any depreciation in Yen would benefit GM as it would have to pay less in dollar terms. 4. Competitive Exposure – This exposure arises due to competitive advantage that GM’s competitors get due to Yen depreciation. Also called economic exposure, this arises 7

when Japanese automakers achieve cost savings and are able to pass on to consumers which results in GM losing sales.

A B

General Motors Net Exposure in Yen (All figures in $ billion) Commercial Exposure 0.9 Assumptions: Based on forecasted receivables and payables Investment Exposure 0.8178 Affiliates Fuji Isuzu Suzuki

C D

Affiliate Exposure GM's Stake Investment Exposure 1.5 20% 0.300 1.02 49% 0.500 0.09 20% 0.018 Total 0.818

Exposure due to Outstanding Debt Competitive Exposure

0.5 4.78

GM Sales from United States (72% Sales come from US) Japanese Content in a Car (20-40%) Cost Saving passed to consumer (15-45%) Depreciation in Yen Price Decline from Yen Depreciation Price Elasticity Decline in Sales (Price Elasticity * Decline in Prices) Erosion in GM's Value (% Decline in Sales *Sales) E

133 30% 30% 20% 1.8% 2 3.60% 4.78

Total Net Exposure = (A + B - C) * (Depreciation in Yen) + D Assumptions: 20% depreciation in Yen

8

5.03

3.

APPROACHES TO MANAGE GM'S COMPETITIVE EXPOSURE

As demonstrated earlier, despite of having its operations primarily based in US, GM faces a significant competitive exposure in Yen terms. Specifically if yen depreciates its Japanese competitors have a significant cost advantage with a yen based cost structure as against the GM who will be comparatively disadvantaged with a dollar denominated cost structure squeezing its margins. There are several tactical and strategic initiatives that GM can take to mitigate the risk arising from this competitive exposure to yen. These are as follows Changing its cost structure: The primary risk of Yen depreciation is the relative cost advantage it provides to Japanese competitors. GM can exploit the same advantage by sourcing its inputs from Japanese suppliers (yen based payables) rather than domestic suppliers (USD payables). Such a move would be relatively easier to implement than making production facilities in Japan. But such a move is fraught with risks as Automobile industry is based on long term relationships and building a supplier network may not be an easy task. Also, GM might have a contract with its suppliers for long period. To add to it most of the suppliers in Japan would have been a part of some Keiretsu (Group) of GM’s competitors who would not be willing to supply to GM. Also, what happens when the currency movement happens in opposite direction? Pricing: Another strategic move could be to index the prices based on Yen movements so with depreciating yen the prices of GM automobiles will also be lowered to be competitive with their Japanese counterparts. However such a move is not recommended as it will cause a loss to GM's margins and is not sustainable in wake of a steady and long term decline in Yen value. Yen Financing: Another option with GM is to borrow in Yen so as it provides a natural hedge against a depreciating yen. Note that since GM will have Yen liabilities , a depreciating yen would benefit GM on one hand and give a relative cost advantage to its Japanese competitors , when properly 9

balanced these two effects can virtually nullify each other. This is an option which is more flexible in terms of implementation and roll back. Also, interest rates in Japan had been very low in Japan in early 2000’s (compared to USA). This could also have kept the cost of financing to a low figure. However, taking Yen financing without “direct” exposure may not go down well with investors. Increasing investments in Japanese automakers: GM already has investments in Japanese affiliates (Fuji, Isuzu and Suzuki) that mitigate its Yen competitive exposures as demonstrated earlier. (See point 3 in the table 1 below). One way of reducing its Yen exposure is to increase investments in Japanese Affiliates. This is a relatively easy option for GM requiring little change in its existing operations strategy and still providing a hedge against yen depreciation. Here, important point is that the affiliates have more Yen denominated liabilities than assets hence, in a way GM benefited when Yen Index rose (Yen Depreciated), thus mitigating Competitive exposure to an extent. Affiliate Exposure ($ GM's Weighted Affiliates billions) Stake Exposure Fuji (1.50) 20% (0.30) Isuzu (1.02) 49% (0.50) Suzuki (0.09) 20% (0.02) Total (0.82)

Table 1 : GM Yen Exposure from Affiliates in $ billions However, there may not be enough suitable investing targets as GM needs to acquire stakes of right targets at appropriate price. Finding such combination is M&A space is difficult most of the times and GM may end up paying too much upfront and end up with a bad investment decision in quest of currency hedging.

Moving Up in Value Chain / Premium Products Although in theory looks like a good strategy, but retreating from certain parts of market and giving up on market segments will further subsidize Japanese Auto makers who already are 10

enjoying benefits of cheap Yen. Also, GM will need to improve its R&D and delivery to cater to “premium” tastes. However, the issue remains that Japanese Automakers can enter the premium segments as well, there are existing premium players such as BMW, Mercedes and Audi and the company of the size of GM can’t survive by being a niche player.

Improving Operational Efficiency Another question which GM needs to ask itself is whether it is operating close to its maximum possible efficiency. If the cost of production can be reined in to an extent such that it can pass on the savings to customers / or increase its margins then the risk of depreciating yen can be controlled to an extent. However, this would involve making hard decisions and decision to shut down a plant or two may end up being more costly with severances and other costs.

Entering in Swap payments An agreement can be made with a party having opposite exposure to a currency, say yen, for payoffs in case of currency fluctuation. For this to be successful GM needs to know about quantitative impact of unit change in Yen dollar index. This has been discussed with detail in Section 4.4 and Section 5.5.

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4.

GM’S COMPETITIVE YEN EXPOSURE (1993 TO 2005)

Yen Dollar index over 1993- 2005 160 140 120 100 80 60

Yen Dollar index

40 20 Q1 2005

Q1 2004

Q1 2003

Q1 2002

Q1 2001

Q1 2000

Q1 1999

Q1 1998

Q1 1997

Q1 1996

Q1 1995

Q1 1994

Q1 1993

0

Source: St. Louis Fed

General Motors Company filed for bankruptcy in 2009. Due to this, we decided to use two sets of analysis one for the old entity which filed for bankruptcy in 2009 and one for the new entity. For analysis of the “old” entity we had to rely on SEC for the financial data points of General Motors Company (the old records are present with entity name “Motors Liquidation Company” at the Sec website). The records were available as far back as the first quarter of 1993 so we decided to use regression on GM’s numbers till fourth quarter of 2005. The numbers for 2006, 2007 and 2008 were not considered for analysis as during those period GM was on verge of collapse and the changes in GM’s numbers were mostly driven by its own uncertainty. Concepts of lags: If yen depreciates now, the effects of this can be seen only after certain period on US Markets as the company will take time to decide on passing the benefits to customers. Moreover, some inventory with dealers will be there which has been procured at “higher rate”. Hence, the effects is said to lag the change in Yen Dollar rate. Lag 1 implies the depreciation of Yen in Q1 will have impact by Q2 and Lag 2 means depreciation of Yen in Q1 will have impact by Q3.

12

4.1 GM’s US Car Sales Exposure Data:

To measure the impact of the Yen Dollar exchange rate on GM US Sales we have collected the data for GM US quarterly sales, Quarterly to Dollar exchange rate, quarterly US GDP, quarterly US SAAR and Quarterly Dollar Index over the period of 1993 to 2005.

Analysis:

GM US Sales are affected by not just by the Yen Dollar exchange rate but many other factors such as Trade Weighted Dollar Index, US SAAR auto sales impact the number of units sold, hence we have regressed all the variables and found that US GDP is a significant variable and other variables have insignificant p-values including the Yen Dollar exchange rate. We further hypothesized that yen dollar exchange rate with a lag might have impact on the GM US Sales. We have regressed that GM US Sales with US GDP and Yen Dollar exchange rate, the regression diagnostics suggest that US GDP has significant explanatory power but the coefficient of the US GDP is negative which is counter intuitive and not possible. Our regression with Yen Dollar with Lag 1 shows that it significantly impacts the GM US Sales. We have further tested with Lag 2 and Lag 3 of Yen Dollar exchange rate, but the regression equation has the most explanatory power at lag 2. Final Regression statistics are as shown below: Regression Statistics Multiple R

0.45

R Square

0.20

Adjusted R Square

0.18

Standard Error

91.93

Observations

52

13

ANOVA Df

SS

MS

F 7.93

Regression

1

67,060

67,060

Residual

50

262,006

8,452

Total

51

329,065

Intercept

Coefficients

Standard Error

1,085.1

141.1

7.692

0.0000

-3.5

1.3

-2.817

0.0084

Yen Dollar Exchange Rate lag 2

t Stat

Significance F 0.01

P-value

The regression equation means that with one unit increase (depreciation of Yen) in Yen Dollar exchange rate will decrease the Quantity of GM US sales by 3,500 units, which is around 0.5% of GM US Sales level. 4.2 GM’s Market Share Exposure

Data:

To measure the impact of the Yen Dollar exchange rate on GM US Sales we have collected the data for GM US market share, quarterly yen to Dollar exchange rate, quarterly US GDP, quarterly US SAAR auto sales and Quarterly Dollar Index over the period of 1993 to 2005. Analysis:

The GM market share in US is affected most by the Yen Dollar exchange rate with Lag 2, while the other variables are not very significantly impacting the GM US market share including the US GDP. The regression coefficient for Yen Dollar exchange rate is -.00085, which means that one unit increase (depreciation of Yen) in Yen Dollar exchange rate will decrease the Market share of GM US by 0.085%.

14

Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations

0.326 0.106 0.078 0.033 52

ANOVA df Regression Residual Total

Intercept Yen Dollar Exchange Rate lag 2

SS 0.004 0.033 0.037

1 50 51

Coefficients 0.398093 -0.00085

Standard Error 0.050 0.000

MS 0.004 0.001

t Stat 7.967 -1.921

F 3.691

Significance F 6.39%

Pvalue 0.000 0.064

4.3 GM’s Net Income Exposure

Data:

To measure the impact of the Yen Dollar exchange rate on GM Net Margin we have collected the data for GM Net Income from Automotive segment, daily yen to Dollar exchange rate, quarterly US GDP, quarterly US SAAR auto sales and Quarterly Dollar Index over the period of 1993 to 2005. Analysis:

The GM Net Margin from auto segment is affected most by the Yen Dollar exchange rate with Lag 2, while the other variables are very insignificant explaining the GM automotive Net Income. The regression coefficient for Yen Dollar exchange rate is -27.5, which means that one unit increase (depreciation of Yen) in Yen Dollar exchange rate will decrease the Net Income from Automotive Segment of GM by $27.5 Mn. This seems like a very large number but it is a cumulative effect of drop in market share, volume sales and increasing cost structure. GM had a very volatile Net Income during the same period ranging from hefty losses of more than $2.5 billion to profit of $1.5 billion. 15

Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations

0.40 0.16 0.14 805.46 52

ANOVA df Regression Residual Total

Intercept Yen Dollar Exchange Rate lag 2

SS 1 3,926,212 50 20,111,761 51 24,037,974

Coefficients 3,569.7 -27.1

Standard Error 1235.92 11.00

MS 3,926,212 648,766

F 6.05

t Stat 2.888 -2.460

P-value 0.00700 0.01967

Significance F 0.019668

4.4 Implication of result on hedging strategy

The above analysis clearly suggests that for every unit rise in Yen dollar index GM loses US$ 27.1 Million per quarter (in the quarter next to next quarter: lagged2). Besides trying to hedge this with conventional methods such as investments, Yen Financing, Changing Cost Structure etc. as discussed in section 3, the company can also try a Swap agreement with a party facing counter risk on Yen dollar rate. The counter party may be another exporter from Japan who loses when Yen Dollar index goes down (Yen becomes costly)for example Canon. The Swap can be set such that for every unit rise in Yen Dollar index GM receives US$ 27.1 Million per quarter from Canon and Vice Versa. The issue with this type of agreement is that in case one sided movement is expected (say long term depreciation of yen) GM may not find a counter party as the Japanese exporter will not see value in the deal. However in the period 1993-2005 the Yen Dollar exchange rate was range bound (see Garph at beginning on Section4), so this type of strategy might have worked. It ignores the other exposures which GM may have and which can net out this competitive exposure. Also, the Rsquare for all analysis is quite low (the %age of times change in value of 16

yen explains change in GM’s number) implying further research might be required before implementing the results.

17

5.

“NEW” GM’S COMPETITIVE EXPOSURE

The present scenario for GM is completely different. Recently the Japanese Yen has settled around a relatively high mark of 80 Yen/ USD. This high benchmark has increased the cost for the Japanese manufacturers who now are making choices to move their factories overseas particularly to places like China and even USA to hedge the currency exposure. Also, South Korean manufacturers have made significant dent in the US Auto markets. The figure below shows the increasing presence of South Korean automakers in USA.

US Auto market share from 1961-2011 by Currency (of Manufacturer) 120 M a 100 r k 80 e t 60 S h a r e

WON US$ Pound

40

JPY

20

EUR 0

Year

Till early 2000’s GM’s 70% of the Auto units were sold in North American Region. Now, nearly 60% of Auto Sales is contributed by counties outside North America. This is displayed in the chart provided in the next page.

18

Unit Sold(in000's)

GM's reducing dependence on North American Markets 2500 2000 1500 1000 500 0

North America

Others

5.1 Issues in measuring quantifying exposure using regression

The “new” GM has been in existence for only 14 quarters and even in the same period has made profit only in 10 quarters. To identify impact of the currency movements on General Motors, we have included Korean Won also in the mix as the US Market Share of Hyundai and Kia has increased. As was done in the previous case, we have tried various combinations of dependent variables (Total World Wide Vehicles Sold, Total Sales, and Net Income) with respect to a combination of independent variables (Yen Dollar Index, Won Dollar index and Euro Dollar Index with and without lags, GDP Growth rate and US SAAR Auto Sales). While regressing we realised that there is no benefit of using a net income kind of variable due to lack of data. Hence, we have used number of cars sold (worldwide) and Net Sales to identify the dollar impact. Through these we will try to go to a Net Income model which will be discussed later on in the section. 19

5.2 GM’S UNIT SALES EXPOSURE (WORLDWIDE)

As discussed earlier, currently GM is having more global exposure in terms of sales. Hence, we have used GM’s total worldwide Unit sale as a dependent variable, while trying out various combination we found out that Japanese Yen and Korean Won both have significant impact (good t-stat, more than 2 for both, Rsquare close to.80) on number of Units Sold by GM Worldwide. Here, one unit increase in Yen Dollar rate (Yen depreciation) reduces the number of GM units sold worldwide by roughly 18,920 Units per quarter. Also, one unit increase in Won Dollar rate by one unit reduces number of GM units sold worldwide by 1,700 Units. Here, the Key thing to note that both impact are lag 1 impact i.e. impact of currency fluctuation in one quarter will be seen in numbers of next quarter. The impact of Korean won might seem smaller than Japanese Yen, yet we must remember that Korean won index is more than 1000 in value while Yen index is less than 80. Hence, we must compare 1 unit change of Yen Index with 10 Unit change of Won Index. So, for GM 10 rise in Won Index causes a fall of 17,000 Unit in worldwide sales per quarter. World wide Units Sold in 000's Vs Currency Exposure Regression Statistics Multiple R 0.9533 R Square 0.9088 Adjusted R Square 0.8922 Standard Error 88.0490 Observations 14 ANOVA df

SS 849658 85279 934937

MS 424829 7753

Coefficients Standard Error Intercept 5773.40 346.75 Japanese Yen lag 1 -18.92 5.23 Korean Won lag 1 -1.70 0.40

t Stat 16.65 -3.62 -4.21

Regression Residual Total

2 11 13

F 55

P-value 0.00 0.00 0.00

20

Significance F 0.00000

Lower 95% Upper 95% Lower 95.0% Upper 95.0% 5010.20 6536.60 5010.20 6536.60 -30.44 -7.40 -30.44 -7.40 -2.59 -0.81 -2.59 -0.81

Over the last few years Korean Won has depreciated against dollar, thus opening a new front of worry for GM in terms of Competitive currency exposure. The relative movement of Won and Yen Index is seen clearly in the chart provided.

1500

130

1400

120

1300

110

1200

100

1100

90

1000 900

80

800

70

700

Yen Index

Won Index

Won Index has been on the rise, Yen index has declined

Won Index

Yen Index

60

Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 2007 2007 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012

Correlation between two indices over last five years =-.503

5.3 GM’s Auto Revenue Exposure (Worldwide)

By trying out various combination independent variables on total worldwide sales in US$ million, we found out again that Japanese Yen and Korean Won both have significant impact (good t-stat, more than / close to 2 for both, Rsquare close to.80). Here, one unit increase in Yen Dollar rate (Yen depreciation) reduces GM’s worldwide Auto Revenues by US$ 237 Million per quarter. Also, one unit increase in Won Dollar rate by one unit reduces GM’s worldwide revenue by US$ 37 Million. Here, the Key thing to note that both impact are lag 1 impact i.e. impact of currency fluctuation in one quarter will be seen in numbers of next quarter. The impact of Korean won might seem smaller than Japanese Yen, yet we must remember that Korean won index is more than 1000 in value while Yen index is less than 80. Hence, we must compare 1 unit change of Yen Index with 10 Unit change of Won Index. So, 21

for GM 10 rise in Won Index causes a fall of US$ 370 Million Per quarter. The Won figure is perhaps more significant because of reasons discussed earlier.

Total Revenues in US Millions VS Currency Exposure SUMMARY OUTPUT Regression Statistics Multiple R 0.923658464 R Square 0.853144958 Adjusted R Square 0.826444042 Standard Error 2034.340594 Observations 14 ANOVA df Regression Residual Total

2 11 13

Intercept Japanese Yen lag 1 Korean Won lag 1

SS MS 264468519.2 1.32E+08 45523958.16 4138542 309992477.3

Coefficients Standard Error 98004.9 8011.6 -231.6 120.9 -37.3 9.3

t Stat 12.2 -1.9 -4.0

F Significance F 31.9519 2.61751E-05

P-value 0.000 0.082 0.002

Lower 95% Upper 95% Lower 95.0% Upper 95.0% 80371.5 115638.3 80371.5 115638.3 -497.7 34.5 -497.7 34.5 -57.8 -16.8 -57.8 -16.8

5.4 Moving to a net income like exposure

To hedge we need to estimate impact on a net income like figure. For that we will assume that every extra unit of revenue is making a marginal contribution to the net income. For that we regressed last 14 quarters of revenues against net income and found out following regression output. That one unit of extra sales contribute to 0.321 units to Net Income (Significant t-stats, Rsquare and P values). Sales Impact in Million USD Multiplication factor Yen Lag 1 Won Lag 1

Net income Impact in Million USD 0.3 -237 -76.1 -37 -11.9

22

Hence, we can say 1 unit rise in Yen Index will cause reduction in GM’s Net Income by US$ 76.1 Million and one unit rise in Won will cause reduction in GM’s net Income by US$ 11.9 Million per quarter. As we have discussed earlier the won exposure when compared with yen exposure needs to be multiplied by 10 and is probably the major concern for GM right now. Net Income VS Total Revenues Regression Statistics Multiple R 0.83 R Square 0.69 Adjusted R Square 0.67 Standard Error 1087.83 Observations 14 ANOVA df Regression Residual Total

Intercept Revenues

1 12 13

SS MS F Significance F 32006966.61 32006967 27.04726 0.000221645 14200463.81 1183372 46207430.42

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% -10047.866 2139.574 -4.696 0.001 -14709.598 -5386.135 -14709.598 -5386.135 0.321 0.062 5.201 0.000 0.187 0.456 0.187 0.456

5.5 Hedging the resulting exposure

Here the recent trend has been that Yen Index has been falling (Yen has Strengthened over US Dollars) in recent past and the trend is likely to continue. Also, Korean Won has been the currency which can provide more problems with its decline against dollar. So one can see that GM can probably take steps to hedge against movement of Korean Won. This can be achieved by Swap agreement with a party facing counter risk on Won dollar rate. The counter party may be another exporter from Korea who loses when Won Dollar index goes down (Won becomes costly)- for example Samsung. The Swap can be set such that for every unit rise in Won Dollar index GM receives US$ 11.9 Million per quarter from Samsung and Vice Versa.

23

The issue with this type of agreement is that in case one sided movement is expected (say long term depreciation of Won) GM may not find a counter party as the Korean exporter will not see value in the deal. It also ignores the other exposures (including correlation impacts) which GM may have and which can net out this competitive exposure. GM can also look into basket of conventional methods such as investments, Won Financing, Changing Cost Structure etc. as discussed in section 3. Won financing may not be as appealing as Yen financing because South Korean interest rates are higher than US interest rates.

24

6.

CONCLUSION

Competitive exposures are difficult to measure and hedge. Moreover, these can evolve and change with time.

Japanese manufacturers who were terrorizing GM with cheap Yen

advantage now have been forced to take measures including shifting production base to USA to protect against rising Yen. On other hand, GM is now much more diversified in terms of geography and currency exposure. However, the current GM is less diversified in terms of number businesses. Also, the equity investment profile has changed. Also, the fluctuation in currency rates have a faster impact taking only one quarter to manifest compared to two quarter before.

Parameter Geography Competitive Currency Equity investments Business

Old GM Mostly North America Yen In Japan, Europe Many Businesses

New GM Worldwide Yen, Won In China (JV), Brazil Mostly Auto

Managing Competitive exposure can’t be a standalone process, but all kinds of exposures need to netted. In case of company such as GM, managing competitive exposure is not merely a financial decision but a strategic one. The entire production, marketing and R&D strategy needs to be tweaked besides using appropriate hedging instruments.

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7.

ATTACHEMENTS

Excel File Containing 1. 2. 3. 4. 5.

8.

GM;’s Performance pre 2008 and post 2008 US GDP information Yen Dollar Index Won Dollar Index US Auto market share info

SOURCES USED

SEC Website “Exchange rate exposure and competition: evidence from the automotive industry” – Rohan Williamson, McDonough School of Business, Georgetown University, Washington, DC 20057, USA St. Louis Fed Wards Auto

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