Finance 520

Case Assignment 5 GM
The CEO of General Motors (GM) would like you to prepare a three-to-four page case memo with an
executive summary. The memo should discuss GMs risk management strategy. You must provide
recommendations about whether and how to modify the interest rate exposure of the most recent debt
financing, taking into consideration liability management policy guidelines, the existing interest rate
exposure, interest rate expectations, and the available risk management products. The following
questions should be addressed in the memo. You should also give a thirty-minute presentation that
brings across the main points of the report.
1) Provide an overview of GM and its financial policies.
2) Discuss the 1991 review of GMs liability management program.
3) What are some rationales for hedging financial risks? First discuss the lack of rationale in a
Modigliani-Miller world with no frictions, and then introduce frictions so that rationales for
hedging can be justified.
4) Discuss some possible objectives for GM when managing interest rate risk. An objective could
ensure that interest rates do not affect at least one of following: firm cash flows; firm value; the
share price; ability to invest in new projects. Discuss in the context of GMs state policies on
pages 4-6. (this question ties in with Questions 2 and 3)
5) The following argument for maintaining a debt portfolio that is predominantly fixed rate is
mentioned on page four: a 1% decrease in auto loan rates results in a 0.2% increase in the
dollar volume of cars sold.
a) Provide qualitative rationales that are for and against this argument. That is, provide
reasons for why a decrease in interest rates (from the point of view of the borrower that
purchases the car) could result in an increase or decrease in the dollar volume of cars sold.
b) Is this argument even valid in its focus on the dollar volume of cars sold? Explain.
c) One wonders where the numbers come from in this argument. Using Exhibit 3, run a linear
regression of percent change in revenues (Y-variable) on percent change in 6-month T-Bill
rates (X-variable).
Use the following alternatives for the Y-variable: percent change in (operating
profits excluding special charges + depreciation); percent change in (operating
profits excluding special charges + depreciation capital expenditures).
Use the following alternatives for the X-variable: percent change in 30-year T-bond
rates; percent change in LIBOR (6 month).
This should produce nine regressions.
d) Are your nine estimated coefficients from part (c) similar? What does this imply about the
reliability of the assumption that lower interest rates result in a small increase in the dollar
volume of cars sold? Do we truly know that GM is adversely exposed to increases in interest
rates?

6) On page 4, the stated goal of GM is to actively manage liabilities and take advantage of
cyclicality and volatility in interest rates and shifts in the yield curve. It is said that there is a fine
line between risk management and speculation. It is also notoriously difficult to forecast interest
rates. With these statements in mind, comment of GMs stated goal.
7) Suppose that it is true that a 1% decrease (increase) in auto loan rates results in a 0.2% increase
(decrease) in the dollar volume of cars sold and operating profits. Is a mix of fixed and floatingrate debt consistent with GMs stated objective?
8) GM issued a 5-year fixed rate note with a 7.625% coupon payment (assume annual payments)
and a $400M face value. They received $399.9M minus commissions and expenses. What is the
cost of debt?
Hint: find the discount rate such that the PV of the coupon payments and face value equals
the $399.9M minus commissions and expenses
9) Consider the following choices for GM:
a. Five-year interest rate swap.
b. The purchase and/or sale of a 9 percent cap on LIBOR.
c. The purchase of a bull spread.
d. Doing nothing.
Would any of these choices reduce the cost of debt for GM? Qualitative discussions of each
choice will suffice.
10) Based on your analysis, in terms of risk management, what is your recommendation for GM?
The case memo should be three to four pages with any useful tables or graphs attached. The memo
should be presented in a professional manner, and with a logical flow, so that the CEO of GM can easily
understand your main points. If you need to make any assumptions, make them clear. Calculations
should be relegated to an appendix. A memo that consists of a mess of calculations and numbers would
not be acceptable.
The case presentation should be about 30 minutes in length. It should also be presented in a
professional manner, and with a logical flow, so that the CEO of GM can easily understand your main
points. The presentation should be informative, concise, and should keep the listener engaged. The
presenter should also be prepared to answer questions from the audience. A maximum of two people
from your group should present your findings.