Liability Management at General Motors: Questions
1) Objective of Risk Management. When managing interest rate risk what should GM’s
objective be? Some possible objectives would be for GM to ensure that changes in interest
rates do not affect operating cash flow, the market value of the firm’s assets, the market value
of the firm’s equity, or GM’s ability to invest in new projects? Be prepared to discuss GM’s
stated policies (see pages 4-6 of case). Are they consistent with what you think should be the
goals of GM’s risk management program?
2) Interest rate exposure. How do changes in interest rates affect General Motors? To answer
this question you should use both your intuition as well as the data provided in the case.
According to the case, a one percent decrease in auto loans rates results in a 0.2% rise in
sales revenues. This number was obtained by running the following regression.
The estimate of α1 would be -0.002 in this case.1
To answer the question of how changes in
interest rates affect general motors, you will need to run some regressions like equation (1).
The necessary data is in Exhibit 3.2
3) Hedging GM’s interest rate exposure. I want you to consider four alternatives for adjusting
the interest rate sensitivity of the $400M five year note which GM is issuing. For each
alternative you should decide how it alters GM’s interest rate exposure. If it is useful you
may want to consider the term structure for LIBOR. Exhibit 7 contains the LIBOR rates as
of February, 1992 for maturities of one to five years. The forward rates implied by these
rates are also calculated. The four alternatives to consider are:
A) Do nothing.
B) A 5 year interest rate swap. GM will agree to pay LIBOR and receive a fixed rate.
C) Sell a 9 percent cap on LIBOR.
D) Purchase a bull spread.
I have intentionally restricted the number of instruments at which I want you to look,
so you can examine how each affects GM’s interest rate exposure. The mechanics of each
transactions are described in the case and the prices of each instrument are described in
Exhibit 8. The premia is the price at which you can buy or sell the instrument. Remember,
you buy at the ask (the high price) and sell at the bid (the low price). This is how banks and
traders make money.
When examining each of the hedging options (B-D), compare GM’s borrowing cost
under each alternative to the cost of the fixed rate debt instrument. The all in cost of the fixed
rate debt instrument is 7.76%, not 7.625%. Contrary to what it says in the case, assume that
interest payments are made annually – not semi-annually.
Ln Sales revenue Autoloan rate ( ) =+ + αα ε 0 1 (1)
2 GM Case Questions
4) Policy recommendations. What should General Motors do? Given the goals of a risk
management program and the effect of each alternative on the interest rate exposure of GM,
what instrument would you recommend for GM? Assume that each of the instruments is
A) Answer the question if you were Stephane Bello.
B) Answer the question if you were Ms. Anne Armstrong, an outside director of GM.
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