MM – 6021

Enterprise Risk Management

Mid-Term Exam

Student Name: R.Indra Adika Putra

Student ID: 29114810

1st Semester – 2015/2016MASTER OF BUSINESS ADMINISTRATION

School of Business & ManagementINSTITUTE TEKNOLOGI BANDUNG

ITB School of Business and

YP-51

Lead the Future

EXECUTIVE SUMMARY

I. Objective

In September of 2001, Eric Feldstein, Treasurer and Vice President, Finance for General Motors, Corp. faced some risky situation which can interfere with the performance of the company, the foreign exchange problem. He had three risk management decision to make, what to do about :

GM's billion dollar exposure to the Canadian dollar GM's exposure to the Argentinean peso of light of the expected devaluation in the

months ahead. The continuing strategic concern about fluctuations in the Japanese yen.

As GM expanded around the world, the magnitude of its exposures to foreign currencies grew. The fluctuation of exchange rate created gains and losses that flowed through GM's reported income statement. GM's Treasurer's Office has a key function as financial risk management.GM Treasury Group-Functional Structure

For foreign exchange, all of GM'S hedging activities were concentrated in two centers: Domestic Finance group in NY ( North America, Latin America, Africa and the Middle East), The Second is ERTC in Europe (European and Asia Pacific ). FX hedging activities were segregated based on geographic correspondence between country a business unit was actually managed and where treasury for that business was controlledThe Corporate Hedging PolicyThe primary objectives of General Motor's FX risk management policy :

Reduce cash flow and earnings volatility. Minimize the management time and costs dedicated to global FX management Align FX management in manner consistent with how GM operates its automotive

business.

II. Analysis

Risk Identification

Based on "Foreign Exchange Hedging Strategies at General Motors, Companies are faced

with the same topic but with different conditions and situations. GM dealing with FX hedging

with different countries and situation. However , FX risk divide into 3 exposure, there are

Transactional , Translational, and Competitive.

The risk dimensional of the company in the GM cases are as follow:

Transactional exposure is the risk, faced by companies involved in international trade,

that currency exchange rates will change after the companies have already entered into

financial obligations. Such exposure to fluctuating exchange rates can lead to major losses for

firms. Translational exposure is the risk that a company's equities, assets, liabilities or income

will change in value as a result of exchange rate changes. This occurs when a firm

denominates a portion of its equities, assets, liabilities or income in a foreign currency.

Whereas competitive exposure is exposure resulting from competing against companies with

different currencies, E.g. Japanese automakers and the depreciation of the yen.

Financial Risk

Market Risk

Interest Rate RiskFX Risk

Commodities Risk

Transactional Exposure

Translational Exposure

Competitive Exposure

Risk Identification Table

Code Description Impact Type Of Risk

C CAD Deviation Problem.

Because USD selected as

primary operating currency of

company, Obviously if

fluctuation of CAD:USD

happens, that will arise earning

volatility and affect on Income

Statement.

That will make the EPS volatility.

Generally, the more stable the

earnings of a corporation, the

more stable the price of its stock.

Investors prefer stocks with stable

prices and a steady uptrend. This

makes financial planning easier

and minimizes the risk of loss.

FX Risk

A Argentine Great Depression,

Devaluation peso (ARS)

against USD from 1 :1 to 2:1

all debts and expenses will be

growing twice, it also decreasing

earning of GM.

FX Risk

Financial Risk

J Yen Depreciation, It will

additional Gross Margin for

Japan Manufacturers, make it

lower price.

Gaining market share of Japanese

manufacturer, also reduction in

GM's unit sales and decreasing

net income.

Market Risk

Risk Assessment

After make risk identification list, we have to make criteria and scoring the Likelihood and

impact of event from risk identification table.

Likelihood Parameter

Criteria Score DescriptionHigh 9-10 Certainly will happenLikely 7-8 The most probable will

happenModerate 5-6 50% happen 50 % not happenUnlikely 3-4 Less likely will happenLow 1-2 Very unlikely to happen

Impact Parameter

Criteria Score DescriptionCatastrophic 9-10 >80% Loss of earningsMajor 7-8 61%-80% Loss of earningsMedium 5-6 41%-60% Loss of earningsMinor 3-4 21%-40% Loss of earningsInsignificant 1-2 0%-20% Loss of earnings

Risk Measurement

Code Description Impact Type Of

Risk

Likelihood Impact

C CAD Deviation Problem.

Because USD selected as

primary operating currency

of company, Obviously if

fluctuation of CAD:USD

happens, that will arise

earning volatility and affect

on Income Statement.

That will make the EPS

volatility. Generally, the more

stable the earnings of a

corporation, the more stable the

price of its stock. Investors

prefer stocks with stable prices

and a steady uptrend. This

makes financial planning easier

and minimizes the risk of loss.

FX Risk 5 8

A Argentine Great

Depression, Devaluation

peso (ARS) against USD

from 1 :1 to 2:1

All debts and expenses will be

growing twice, it also

decreasing earning of GM.

FX Risk

Financial Risk

4 10

J Yen Depreciation, It will

additional Gross Margin

for Japan Manufacturers,

make it lower price.

Gaining market share of

Japanese manufacturer, also

reduction in GM's unit sales

and decreasing net income.

Market Risk

FX Risk

5 6

Risk Mapping of General Motor Corp.

A

9

8 C

7

IMPA

CT

6 J

5

4

3

2

1 1 2 3 4 5 6 7 8 9 10

LIKELIHOODA=Argentina Case J=Japan Case C=Canada Case

Risk Mitigation

Code Description Impact Type Of Risk

Risk Mitigation Treatment

Risk Mitigation Description

C CAD Deviation

Problem. Because USD

selected as primary

operating currency of

company, Obviously if

fluctuation of

CAD:USD happens, that

will arise earning

volatility and affect on

Income Statement.

That will make the EPS

volatility. Generally,

the more stable the

earnings of a

corporation, the more

stable the price of its

stock. Investors prefer

stocks with stable

prices and a steady

uptrend. This makes

financial planning

easier and minimizes

the risk of loss.

FX Risk Transfer Forward

Contract

Option

Contract

A Argentine Great

Depression, Devaluation

peso (ARS) against

USD from 1 :1 to 2:1

All debts and expenses

will be growing twice,

it also decreasing

earning of GM.

FX Risk

Financial Risk

Transfer Debt Hedging

J Yen Depreciation, It

will additional Gross

Margin for Japan

Manufacturers, make it

lower price.

Gaining market share

of Japanese

manufacturer, also

reduction in GM's unit

sales and decreasing

Market Risk

FX Risk

Transfer/Control Swap

Agreement

Changing

Cost

net income. Structure

III. Conclusion and Recommendation

3.1 Conclusion

From the cases encountered General Motors Corp., they are faced with three different

conditions in which the first condition (Canada) GM to face the problem of currency

fluctuations CAD against the USD, resulting in earnings volatility. Earnings volatility would

affect the EPS and the stock price, investors prefer stocks with stable prices. To tackle the

problem GM Canada considering forward contract and option contract to fix earning

volatility problem.

In the second condition (Argentina), The Argentinean government is facing significant

financial problems which throws doubts on its default. The country has very poor economic

situation with no reforms and recent devaluation of currency has caused the managers to

think over the strategy that should be followed. The manager did perform some hedging

calculation though however hedging is used where there is risk in the short term and where

risk cannot be transferred. Hedging strategy of GM should not be altered in this regard

however by other options we can find a solution. Other options to deal with that could be

borrowing in the local currency as it minimizes the level of payments that should be remitted

to the parent.

In the third condition (Yen Depreciation), Depreciation in Yen leads to additional gross

margin for Japanese, and make it lower price in market and gaining market share of Japanese

manufacturer directly reduce the GM market share and profit. This is part of risk in

competitive exposure, exposure resulting from competing against companies with different

currencies .Competitive exposures are difficult to measure and hedge. Moreover, these can

evolve and change with time.

Due to its sizable 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.

3.2 Recommendation :

The company faces significant level of currency risk due to geographical representation in a

number of countries. The company has non centralized treasury function that has a number of

tasks that are performed non-centrally. The company should make it centralized fully and try

to net-off the amounts and should created best possible profitable results according to USD

not local currencies.

In CAD case, GM currently has hedge ratio of 50% and as we have seen the level of high

volatility due to lower level of hedge ratio we suggest change in it. The hedge ratio should at

least be 75% for commercial transactions to predict the results of earnings with more

certainty. That will make stability in stock price of GM and give a secure feeling of investor.

In Argentina case, GM have to minimizing the translational risks by borrowing in local

currency so that overall risk can be netted off. The company should also evaluate the

economical landscape of any country where it starts to work on because currencies are highly

volatile to the changes in economical factors.

In Yen depreciation case, Besides using conventional hedging method such as investments,

Yen financing, Changing cost structure, GM can also try a swap agreement with a party

facing counter risk on Yen dollar rate. The counterparty may be another exporter from Japan

who loses when yen dollar index goes down.