1. How will changes in interest rates affect General Motors' business? Speculate on the various ways in which changes in interest rates influence the demand for autos, the prices the firm can charge, its input costs, etc. Apart from engaging in derivative securities, like those discussed in the case, how could a firm like GM control its exposure to interest rates? Interest rate levels are a factor of the supply and demand of credit; an increase in the demand for credit will raise interest rates, while a decrease in the demand for credit will decrease them. Conversely, an increase in the supply of credit will reduce interest rates while a decrease in the supply of credit will increase them.GMs financial policy consisted of a set of targets for key financial management activities, including the management of cash balances, leverage, liability structure, risk management, and dividends. Changes in interest rates will result in an increase on the firms borrowing costs. Increase in interest rates would also result in high auto loan and consumers will buy less which will then affect the firms revenues. On the other hand however a volatile interest rate will affect business operations as well as cash flow due to changes in the cost of borrowing. In order to control the exposure to interest rate, GM can implement future contracts, swaps, forward contracts or forward rate agreements.

2. How does managing interest rate exposure differ for a bank and for an industrial firm like GM? Interest rate risk is, in general, the potential for changes in rates to reduce a banks earnings or value. As financial intermediaries, banks encounter interest rate risk in several ways. The primary and most often discussed source of interest rate risk stems from timing differences in the repricing of bank assets, liabilities, and off-balance-sheet instruments. These repricing mismatches are fundamental to the business of banking and generally occur from either borrowing short term to fund long-term assets or borrowing long term to fund short-term assets. The supply of credit is increased by an increase in the amount of money made available to borrowers. Banks can use the money deposited by their customers for its business and investment activities, at the same time lend out that money to other customers. The more banks can lend, the more credit is available to the economy. And as the supply of credit increases, the price of borrowing (interest) decreases. Credit available to the economy is decreased as lenders decide to defer the re-payment of their loans. This in turn will increase the interest rates in the economy. As opposed to banking institutions, industrial firms and corporations manages interest rates exposure by engaging in hedging activities. Hedging instruments allows protection against future fluctuations and price volatility in the future. Compared to bank that primarily plays the role as lenders, industrial firms as the borrowers can also manage interest rate exposure through specialized derivative instruments like forwards, futures, swaps and options.Alternatively, if firms believe they can time the market, thereby reducing their cost of capital, then the interest rate exposure selection should be driven by movements in interest rates. Firms can reduce their interest costs by actively managing their interest rate exposure as interest rates change. When the yield curve is steep, firms that select a floating interest rate exposure will have significantly lower interest costs, at least in the short term, than firms with a fixed exposure.

3. What should be GM's over-arching policy toward managing interest rate exposure? For example, should GM seek to ensure that changes in interest rates do not affect operating cash flow? The market value of the firm's equity? GM's ability to invest in new technologies? Should it abandon all efforts to manage its interest rate exposure? Be prepared to discuss GM's stated policies. How do you interpret these policies?

GMs primary policy in managing interest rate exposure is basically identify the risks, measure and then manage them. GM should emphasize the importance of focusing on their core businesses and not looking at currency mismatches to generate extra profit.GM can leave their foreign exchange exposures unhedged to benefit from the movement of the currency in their favour and save the cost of hedging rather than concentrating on their core business to generate profits. GM should also include in their risk management policy the risks associated with un-hedged exposures and the careful selection of hedging instruments, besides having a clear thought process in managing currency and interest rate risk as well as market risk.