Finance - Hedging Strategies - Assignment Example

The essence of hedging strategies is to reduce business risks while deterring the creation of additional risks. Multinational firms encounter a multitude of risks, particularly as a result of their competitive exposures across the globe. General Motors has along experienced competitive exposure due to the Japanese yen. This exposure has a lot to do with the depreciating Japanese yen. However, the company is yet to establish clear guidelines to deal with the competitive risk caused by the yen’s continued depreciation.

In essence, the company’s hedging strategies do not provide lucid hedging strategy guidelines. General Motor’s treasurer and finance vice-president Eric Feldstein had to establish robust hedging strategies to counter the risk posed by the depreciating Japanese yen. General Motors was incurring substantial losses as a result of market changes with regard to the US dollar and Japanese yen (Desai & Veblen, 2006). General Motors, therefore, sought to minimize currency risk to maximize its profitability.

GM established a passive policy that involved hedging half of its commercial exposures on a regional basis. This means that GM’s hedging strategy involved a clear distinction between commercial and financial exposures. GM defined its commercial exposures as cash flows related to its ongoing business, for instance, payables and receivables and its financial exposures as dividends and debt repayments. The primary purpose of GM’s overall hedging strategy was related to its foreign exchange risk management policy.

This hedging strategy aimed at reducing the volatility between cash flow and earnings by hedging cash flows i.e. transaction exposures only and disregard translation (balance sheet) exposures. In addition, GM’s strategy aimed at minimizing the cost, as well as management time devoted to the management of global foreign exchange. This policy was an outcome of an internal audit, which showed that resource investment in active foreign exchange management had not led to substantial operation of passive benchmarks.

This led to policy changes, as well as the adoption of a passive approach in place of the active one. Lastly, GM’s hedging strategy aimed at aligning the company’s foreign exchange management with GM’s operation of its automotive business (Desai & Veblen, 2006). This move reflected the assumption that financial management needs to conform to the geographic, operational footprint of GM’s overlying business. Overall, GM’s hedging strategy has effectively reduced its foreign exchange risks, enabling the company to operate efficiently in the Japanese market.

JP Morgan is a US-based financial company that rolled out its business in other regions of the world. While companies establish hedging strategies to protect them from risks, particularly future risks, wrong practices can cost massive losses to a company. One such company is JP Morgan, which used derivatives as its primary hedging strategy resulting in losses of up to $ 2 billion. JP Morgan adopted the use of risky derivatives rather than less risky bonds used by its competitors such as Bank of America, Citigroup Inc.

and Wells Fargo & Co. (Griffin & Moore, 2012). The later financial companies do not trade in credit-default swaps with regard to their indexes. However, JP Morgan accumulated massive credit-default indexes, which resulted in, price moves within the financial industry. Unlike JP Morgan, other financial industry players use