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Case: Currency hedging strategies at General Motors: transaction and conversion risks General Motors (GM) is among the world's largest automobile manufacturers. GM manufactured vehicles in


 

Case: Currency hedging strategies at General Motors: transaction and conversion risks

General Motors (GM) is among the world's largest automobile manufacturers. GM manufactured vehicles in over 30 countries, and they were sold in over 200 countries. GM's Treasurer and Vice President of Finance had to balance the hedging policy and economic aspects of GM's exposure to fluctuations in the Canadian dollar.

This case study examines an important role of the General Motors (GM) Treasury department, which is managing currency exposure and financial transaction risk.

Questions:

4. Suppose that on September 15, 2001, a GM's financial officer hedges a CAD 10 million cash outflow three months in the future (this is 50% of a CAD 20 million notional exposure), with a forward contract. The spot exchange rate on the date of the transaction is 1.5621 and the forward rate is 1.5667: GM will buy 10 million CAD in 3 months at this rate. Will this transaction generate a gain or a loss for GM if the spot exchange rate CAD/USD in 3 month is 1.5898 (depreciation of 1.77% of the CAD)?

5. Now suppose that instead of hedging the exposure with a forward contract, the GM's financial officer use a currency option to hedge the CAD 10 million outflow. The officer will buy a CAD call/USD put with a notional amount of CAD 10 million. The spot exchange rate on the date of the transaction is 1.5621 and the strike price for a 3-month CAD call/USD put is 1.5667. The cost of the option is 1.45% of CAD 10 million/1.5667= 92,551.22 USD. Will this transaction generate a gain or a loss for GM if the spot exchange rate CAD/USD in 3 month is 1.5898 (depreciation of 1.77% of the CAD)?

6. Based on your answers to questions 4 and 5, discuss the difference between an exchange rate forward contract and an exchange rate option contract.

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