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YP-51

ITB School of Business and Management

Lead the Future

MM – 6021

Enterprise Risk Management

Mid-Term Exam

Student Name: Hanindita Guritna


Student ID: 29114713

1st Semester – 2015/2016


MASTER OF BUSINESS ADMINISTRATION

School of Business & Management


INSTITUTE TEKNOLOGI BANDUNG
EXECUTIVE SUMMARY

General Motors was world’s largest automotive manufacturer with unit sales of 8.5 million
vehicles in 2001 amounted of 15.1% of the world’s automotive market share. In 2000, GM
generated earnings of $4.4 billion on sales of $184.6 billion. As GM expanded around the
world, the magnitude of its exposures to foreign exchange grew. Because exchange rate
fluctuations created fluctuations in GM’s financial statement, it was important to understand
GM’s foreign exchange flows and manage the amount of earnings and cash flow volatility
they imposed on GM.

The Risk Management of GM set the objectives of its foreign exchange hedging policies in
order for reducing cash flow and earnings volatility, minimizing the management time and
cost dedicated to global FX management, and aligning FX management in a manner
consistent with how GM operates its automotive business.

In order to know what kind of risks that GM were exposed due to its foreign exchange policy,
a risk identification need to be carried on. Based on this risk identification, it is found that
GM was exposed to the risk of Canadian Dollar to US Dollar volatility, Argentinean Peso to
US Dollar volatility, and reducing its market share due to Japanese Yen to US dollar
depreciation. Those risks are then mapped into 5x5 matrix in order to identify the appropriate
mitigation strategy, such as transfer, avoid, or control.
I. Introduction
I.1. Company Profile
General Motors was the world’s largest automaker and in 2001, GM had unit sales of 8.5
million vehicles and 15.1% worldwide market shares. Founded in 1908, GM had
manufacturing operations in more than 30 countries and its vehicles were sold in
approximately 200 countries. Due to its international operations, GM were exposed to the
foreign exchange risks that arises due to its presence at a number of geographical locations,
and transactions in different foreign currencies. The labor costs for its 365,000 employees in
that year amounted to $19.8 billion, only $8.5 billion was US-based personnel. In addition to
vehicles, GM also has other product lines, including financial services, satellite television and
commercial satellite services, and locomotives and heavy duty transmission. GM shares was
also traded on the NYSE and was a component of the Dow Jones Industrial Average.

GM’s Treasurer’s office performed a full range of corporate treasury functions and one of the
key functions of the Treasurer’s Office was financial risk management. This included
management of market risk (foreign exchange, interest rate and commodities exposure) but
also counterparty, corporate, and operational risk. All of GM’s financial risk management
activities were subject to oversight by the Risk Management Committee which set treasury
policy for GM and its subsidiaries. Treasury policy included evaluating the parameters and
benchmarks for managing market risks, determining criteria for assessing counterparty credit
risk, determining thresholds for property and liability insurance coverage, as well as
reviewing internal control aspects of operating policies and procedures.

I.2. Objectives
Its market share in Latin America was 20% and in Europe had reached 10%. Increasing
market share in Asia, which stood at 4%, was a major strategic objective for GM. Apart from
the major strategic objective for GM, it has also key objectives in foreign exchange risk
management policies, which are:
- Reduce cash flow and earnings volatility
- Minimize the management time and costs dedicated to FX management
- Align FX management in a manner consistent with how GM operated its automotive
business.
II. Analysis
II.1. Risk Identification
The first step for risk management analysis is to identify what are the risks that the company
are facing. The types of risks that can occur in a company can be seen from the figure below.

Figure 1: Types of Risks

Because of the management’s objective is just regarding its foreign exchange risk, the
following risk identification only considers risk that affects GM’s foreign risk exposure. The
risks that exposed General motors in term of foreign exchange is shown in the following
table.

Table 1: Risk Identification

No Risk Description Loss Type of Risk


Volatility of USD vs. CAD
because of the usage of USD Fluctuations of
1 Forex Risk
as the functional currency of Cash Flows
GM Canada
Argentinean Peso's Double the amount
devaluation against USD due of Debt which Forex Risk, Economic
2
to decreasing Argentina's caused to decrease Risk
default rating the earnings
Decrease in GM's
Depreciation of Japanese
Market Share
Yen (JPY) to USD, resulted Forex Risk, Business
3 compared to its
in lower costs for Japanese Risk
Japanese
firms
competitors
II.2. Risk Assessment
The next step after the risks has been identified is to measure it. Measuring risk can be done
by formulating the probability (percentage of risk that can occur) and the severity
(measurement of impact of the specified risks). A matrix will then be developed using the
severity and probability of a certain event as the axis. In this case, the matrix used is 5x5
matrix, and the description of the probability and the severity is as follow.
Table 2: Probability Parameter

Probability
Criteria Score Description
Very High 5 Certainly happen
High 4 Most probably happen
Medium 3 Sometimes happen
Low 2 Less likely to happen
Very Low 1 Never happen

Table 3: Severity Parameter

Severity
Criteria Score Description
Very High 5 Very Highly reduced company’s financial position
High 4 Highly reduced company’s financial position
Medium 3 Reduced company’s financial position
Reduced company’s financial position by a small
Low 2
amount
Very Low 1 Not reduced company’s financial position

Table 4: Risk Assessment

No Risk Description Loss Type of Risk Probability Severity Score


Volatility of USD vs.
CAD because of the
Fluctuations
1 usage of USD as the Forex Risk 5 4 20
of Cash Flows
functional currency
of GM Canada

Argentinean Peso's Double the


devaluation against amount of
USD due to Debt which Forex Risk,
2 2 4 8
decreasing caused to Economic Risk
Argentina's default decrease the
rating earnings
Decrease in
Depreciation of
GM's Market
Japanese Yen (JPY)
Share
3 to USD, resulted in Market Risk 4 3 12
compared to
lower costs for
its Japanese
Japanese firms
competitors
Total Score 40

4 2 1

3 3
Severity

1 2 3 4 5

Probability

1-7
Low
8-15
Medium
>15
High

Figure 2: Risk Mapping


II.3. Risk Mitigation
In order to reduce the risks that have been identified previously, mitigation steps need to be
carried on. The appropriate risk mitigation strategy is based on the quadrant of the risk
mapping from the risk identification.

Figure 3: Risk Mitigation Strategy

Based on the risk mitigation strategy above, hence the appropriate mitigation of the risks
identified from the foreign exchange strategy of General Motors are:
Table 5: Risk Level and Mitigation Strategy

Risk
No Risk Description Mitigation Action
Level
Volatility of USD vs. CAD because of the Using CAD as the functional
1 usage of USD as the functional currency High Avoid currency of GM Canada
of GM Canada instead of USD

Argentinean Peso's devaluation against


Mediu
2 USD due to decreasing Argentina's Transfer Borrow in Argentinean Peso
m
default rating

Use natural hedging strategy


by producing cars in Japan in
Depreciation of Japanese Yen (JPY) to
Mediu order to reduce costs due to
3 USD, resulted in lower costs for Japanese Control
m depreciation in JPY and
firms
increase market shares in
Asia.

The mitigation strategy can result in lowering either probability, impact, or both. After the mitigation,
the resulting risk mapping will look like this:
5

4 2 1

3 1* 3
Severity

2 2*

1 3*

1 2 3 4 5

Probability

III. Conclusion and Recommendation


III.1. Conclusion
Based on the Risk Identification and Mapping of General Motor’s foreign exchange policy
due to its global operations, GM is exposed to the high level of foreign exchange risks,
especially risks from volatility of Canadian dollar to US dollar, volatility of Argentinean Peso
to US dollar, and volatility of Japanese Yen to US dollar. These exposures from foreign
exchange can caused volatility in GM’s financial statement.

Based on the key objectives set by GM’s treasury office in foreign exchange hedging strategy,
the current hedging strategy is not enough to mitigate the risks that caused by those 3
volatility in foreign exchange currencies.

III.2. Recommendation
In order for GM to realize its key objectives of the foreign exchange policies is by reducing
its exposure to foreign exchange currencies, for example rather than using regional functional
currency, they should use a universal currency to reduce the foreign exchange exposure to the
company and hence realizing the key objectives set by the treasury office.