Gm Vs Southwest Hedging Strategy

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Financial risk is the risk a corporation faces due to its exposure to market factors such as interest rates, foreign exchange rates, commodities and stock prices. Financial risks for the most part, can be hedged due to the existence of large, efficient markets through which these risks can be transferred. This is unlike operating risk, which is associated with more manufacturing and marketing activities. Operating risk cannot be hedged because these risks are not traded.

In GM’s case they used a passive hedging policy in which they hedged 50% of all significant foreign exchange exposures arising from cash flows associated with ongoing business. Passive hedging is used by highly risk-averse companies that would like to be completely certain of their future cash flows through hedging a significant portion of their risk exposure. This can be achieved by locking in a specific price either through long- term contracts between a supplier and buyer, or through a derivatives contract such as futures, forward or swaps, which are available on most leading commodity exchanges. In the case of GM, they used forward contracts to hedge exposure arising within six months. GM’s longer-term strategy is that of options, which allows them to either buy or sell in the spot market without necessarily being committed to hedge contract. But such a method imposes a heavy hedging cost in the form of option premiums which have to be paid up front at the time of hedging.

The hedging strategy that I have chosen is that of Southwest Airlines strategy over the past decade. Up until the 3th quarter of 2008 they enjoyed 69 straight quarterly profits dating back to 1991. In 2008 Southwest had over 70% of its fuel needs hedged at around $51 a barrel. Using an...

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...mpany overall. They do not take the calculated risks that other foreign auto manufactures have done in the past and they have been very slow in implementing any kind of fuel efficient cars. Southwest has proved to be a very wise and smart player in the airline industry, even though they posted losses in the past 2 quarters, this does not overshadow the 17 year streak, which has allowed them to expand more than any other airline in the industry. Southwest would be my preferred business to work with.

Bibliography

1: http://www.kellogg.northwestern.edu/research/fimrc/papers/jet_fuel.pdf

2: http://news.morningstar.com/articlenet/article.aspx?id=271669

3: http://www.chron.com/disp/story.mpl/business/steffy/6063444.html

4: http://www.purchasing.com/article/CA6631782.html

Resources

http://www.usatoday.com/money/industries/travel/2008-07-23-southwest-jet-fuel_N.htm

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