An evaluator at general motors responsible for looking after and structuring the design of the company’s debt is to determine how to change the interest rate exposure of the company’s latest debt proposal, if it is favorable. The evaluator must consider the company’s rules and regulations pertaining to the liability management, the company’s current interest rate exposure, his own estimates of the interest rates and the broad array of the interest rate goods present. He must choose between allowing the fixed-rate tool to remain unchanged or to join a swap, cap, interest rate choice or a swap option deal.
Swaptions 2 by 5
Annual forward ratio
6 months forward ratio
LIBOR at discount to AA
6 months LIBOR rate
Net cash flow from bonds
Fixed rate swap payments received
Premium on writing the call
Floating rate paid
NPV of cash flows
Swaptions 3 by 5
How will changes in interest rates affect GM’s business? Try to quantify this effect as best you can. Speculate on the various ways in which changes in interest rates influence the demand for autos, the prices the firm can charge, its input costs, etc. Apart from using derivative securities like those discussed in the case, how else could a firm like GM control its exposure to interest rates?
Evaluate each of the options that Stephane Bello faces to hedge interest rate risk. Evaluate how each of the options affects the risk of the issue.
What should be GM’s over-arching policy toward managing interest rate exposure? For example, should GM seek to neutralize the effect of interest rate changes on operating cash flow? market value of equity? or to abandon all such efforts? GM’s ability to invest in new technologies? Be prepared to discuss and interpret GM’s stated policies.
How has GM measured its exposure? How would you propose that GM measure its interest rate exposure?
How would you propose that GM reports the interest rate exposure of its business, and of its liabilities?
What role does a “rate view” play in the liability management policy at GM? What role should it play in GM’s liability management program and why?