Translational CAD
GM is exposed to fluctuations of the Canadian dollar, where it faces transactional and translational currency risk exposures that need to be hedged. GM’s transactional CAD exposure happens when GM buys or sells its products on credit or even lends in foreign currency. The company uses three different solutions for hedging the risks. They do it through forwarding market hedge, where firms buy a forward contract for hedging the risks that are associated with currency fluctuations. Additionally, it uses a money market hedge where the company borrows in one currency in which it uses for receiving payment during the due date, then converts it into local currency then invests it. So when the loans are due, the company pays back using the money generated from its operations. On rare occasions, GM uses option market hedging where it purchases an option then hedges its risk. The purchase options offer asymmetric risk protection. The losses are premium paid for the opportunity, which avails a higher potential for profit in cases where the currency is volatile and is over the exercise prices.
Translational CAD exposure happens when the company has foreign subsidiaries, as well as when their financial statements are converted in the home currency for reporting purposes. This type of exposure can be hedged through a balance sheet hedge where the company offsets the risks through maintenance of an equal amount of assets and liabilities for every currency which offsets each other. Still, through swaps, GM can exchange some amount with another firm where they agree returning the funds after some time.
Even though translational risks are non-economic risks, there is a need of hedging them. The fluctuations in the exchange rates that are between functional and non-function currency lead to significant gains or losses in the company. For instance, if GM has a wholly-owned subsidiary whose assets are dominated in US dollars while the reporting currency of GM is in euros. So in the case where euros appreciates against US dollars, then the value of GM assets lowers when translated to euros. It leads to a loss in the value of the group’s assets. Hence, GM can spend its resources in hedging its translational risks, which has no effects on the firm’s value.