Top Banner
Liability Management at GM Group 3 ANDRE, CHUN MUN WAI AKHIL BHATNAGAR GOH PENG YANG DAVY Brian PARK BONGHEE
34
Welcome message from author
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Page 1: Liability management at GM

Liability Management at GMGroup 3ANDRE, CHUN MUN WAIAKHIL BHATNAGARGOH PENG YANG DAVY Brian PARK BONGHEE

Page 2: Liability management at GM

Noncallable five-year note, with a fixed interest rate of 7.625%, guided by policy on liability portfolio management, the current structure of its liabilities, and Mr. Bello’s best reading of trends in the bond markets.

Story LineIn Feb. 1992, GM plans to raise U$400M through a public offering

Engage in a wide range of derivative activities including Interest-rate swaps, Caps, Treasury options or Swap option(Swaptions), based on Mr. Bello’s judgment of the future of interest rates and volatility, the future shape of the yield curve, and the interest-risk exposure

Page 3: Liability management at GM

GM’s Financial Policy

To ensure the stability of corporate cash flows, to facilitate and support new and existing product plans and other strategic initiatives, and to create and return shareholder value.

• GM’s financial policy consisted of a set of targets for key financial management activities, including the management of cash balances, leverage, liability structure, risk management, and dividends

Page 4: Liability management at GM

GM’s Liability Management Policies

Home Base – matching liabilities to assets• To ensure that the general nature of the firm’s liabilities were

closely related to those of its earning assets, so that “any impact on operating cash flow caused by movements in interest rates is largely offset by changes in the value of the firm’s liability portfolio.”

Active Management around home base

• By adjusting the composition of GM’s liability portfolio in step with changes in rates over time, GM should be able to accomplish a meaningful reduction in total debt service costs.

Page 5: Liability management at GM

Rate View February 1992

Interest rates decline due to heavy supply of bonds sold by the U.S. Treasury

Bond market rally over the next two months due to weak economy during the first half of the year, high level of uncertainty in the market

The yield curve flatten as the spread between long and short rates converged

Based on external and internal information, market is uncertain and economy is transitional

Page 6: Liability management at GM

How changes in interest rates affect GM?

• Increase firm’s borrowing costs affects the profitability • High auto loan, consumer buy less affects revenues

High Interest Rate

• Changes in the cost of borrowing affect business operations and decision as well as cash flow

Volatile Interest Rate

Auto loan rate versus revenue (Based on US Federal reserve archives)y = -0.0794x + 12.338, R² = 0.7182- Passed P-value Test, 71.8% could be explained by the formula.The equation was statistically significant at 95% confidence interval.

• Negative relationship• 1% increase in the interest rate would result in

a 7.94% drop in revenue Auto loan vs.

Revenues

Page 7: Liability management at GM

Stephane Bello’s Alternatives

• Do Nothing• Swaps (5-year, 3-year, 2-year)• Options on Treasury Notes• Benchmark Caps• Swaptions

Page 8: Liability management at GM

Do Nothing (Issuance of $400m debt)Principal ($) 400Mn     Other feature:          Fixed Coupon Rate 7.63%      1. No call provisions        

Interest to be paid 0.50 (semi annually)   2. No sinking fund        

Semi annual Payment Amount ($) 15.25 Mn     3. No right to extend maturity      Maturity 5.00 years                  No. of Payments 10.00                    Bond Face Value ($) 100.00                    Issued at Discount 99.98%                   Notes sold for ($) 99.976                                                                                        

($ Mn) - 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 Gross Proceeds 399.904                     Less: underwriter commission - 1.80                     Less: expenses - 0.18                     Interest payments   - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 Principal repayment                     -400.00 Net Cash Flow 397.93 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 -415.25 NPV of Cash Flows 397.93 - 14.68 - 14.13 - 13.61 - 13.10 - 12.61 - 12.14 - 11.69 - 11.25 - 10.83 -283.90 Yield Rate 7.902%                    

Bond Issued

Receive            

  Pay            

    Fixed Fixed Fixed Fixed Fixed  

Page 9: Liability management at GM

Do Nothing (Conclusion)

• Lock in a coupon rate of 7.63%

• Effective cost of capital increases (After underwriter fee and other expenses) is 7.902%

• Insulate its cash flows fully from any interest rate exposure

• Not be able to lower its cost of debt should interest rates decline.

Page 10: Liability management at GM

Swaps5 yr Swaps:            

              Bond Issued

Receive            

  Pay            

    Fixed Fixed Fixed Fixed Fixed  

               

    Fixed Fixed Fixed Fixed Fixed  

Swap

Receive            

  Pay            

   

Floating

Floating Floating Floating Floating  

Page 11: Liability management at GM

Swaps (5-year)Fixed rate: 7.13 – 7.17%Floating Rate spread over Treasuries: 0.42%- 0.46%Annual LIBOR: 7.12%

FIXED RATE:                      

($ Mn) - 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00

Net Cash Flow from Bonds 397.93 (15.25) (15.25) (15.25) (15.25) (15.25) (15.25) (15.25) (15.25) (15.25) (415.25)

Fixed Rate SWAP payments received 0.00 14.26 14.26 14.26 14.26 14.26 14.26 14.26 14.26 14.26 14.26

Total 397.93 (0.99) (0.99) (0.99) (0.99) (0.99) (0.99) (0.99) (0.99) (0.99) (400.99)

Page 12: Liability management at GM

6 Monthly Variations 15% 15% 15% 15% 15% 15% 15% 15% 15% 15%

0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00                   53%                46% 46%              40% 40% 40%            35% 35% 35% 35%          30% 30% 30% 30% 30%        26% 26% 26% 26% 26% 26%      23% 23% 23% 23% 23% 23% 23%    20% 20% 20% 20% 20% 20% 20% 20%  17% 17% 17% 17% 17% 17% 17% 17% 17%

15% 15% 15% 15% 15% 15% 15% 15% 15% 15%0% 0% 0% 0% 0% 0% 0% 0% 0% 0%

-15% -15% -15% -15% -15% -15% -15% -15% -15% -15%  -17% -17% -17% -17% -17% -17% -17% -17% -17%    -20% -20% -20% -20% -20% -20% -20% -20%      -23% -23% -23% -23% -23% -23% -23%        -26% -26% -26% -26% -26% -26%          -30% -30% -30% -30% -30%            -35% -35% -35% -35%              -40% -40% -40%                -46% -46%                  -53%

Swaps (5-year)Floating rate

Page 13: Liability management at GM

6 Month Libor Projections                    

0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00                   5.44%                5.19% 5.19%              4.98% 4.98% 4.98%            4.80% 4.80% 4.80% 4.80%          4.63% 4.63% 4.63% 4.63% 4.63%        4.49% 4.49% 4.49% 4.49% 4.49% 4.49%      4.37% 4.37% 4.37% 4.37% 4.37% 4.37% 4.37%    4.27% 4.27% 4.27% 4.27% 4.27% 4.27% 4.27% 4.27%  4.17% 4.17% 4.17% 4.17% 4.17% 4.17% 4.17% 4.17% 4.17%

4.09% 4.09% 4.09% 4.09% 4.09% 4.09% 4.09% 4.09% 4.09% 4.09%3.56% 3.56% 3.56% 3.56% 3.56% 3.56% 3.56% 3.56% 3.56% 3.56%3.03% 3.03% 3.03% 3.03% 3.03% 3.03% 3.03% 3.03% 3.03% 3.03%

  2.95% 2.95% 2.95% 2.95% 2.95% 2.95% 2.95% 2.95% 2.95%    2.85% 2.85% 2.85% 2.85% 2.85% 2.85% 2.85% 2.85%      2.75% 2.75% 2.75% 2.75% 2.75% 2.75% 2.75%        2.63% 2.63% 2.63% 2.63% 2.63% 2.63%          2.49% 2.49% 2.49% 2.49% 2.49%            2.32% 2.32% 2.32% 2.32%              2.14% 2.14% 2.14%                1.93% 1.93%                  1.68%

Swaps (5-year)Floating rate

Page 14: Liability management at GM

Payment Projections                     0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00                   21.75                 20.77 20.77               19.92 19.92 19.92             19.18 19.18 19.18 19.18           18.54 18.54 18.54 18.54 18.54         17.98 17.98 17.98 17.98 17.98 17.98       17.49 17.49 17.49 17.49 17.49 17.49 17.49     17.06 17.06 17.06 17.06 17.06 17.06 17.06 17.06   16.70 16.70 16.70 16.70 16.70 16.70 16.70 16.70 16.70 16.38 16.38 16.38 16.38 16.38 16.38 16.38 16.38 16.38 16.38 14.24 14.24 14.24 14.24 14.24 14.24 14.24 14.24 14.24 14.24 12.10 12.10 12.10 12.10 12.10 12.10 12.10 12.10 12.10 12.10   11.78 11.78 11.78 11.78 11.78 11.78 11.78 11.78 11.78     11.42 11.42 11.42 11.42 11.42 11.42 11.42 11.42       10.99 10.99 10.99 10.99 10.99 10.99 10.99         10.50 10.50 10.50 10.50 10.50 10.50           9.94 9.94 9.94 9.94 9.94             9.30 9.30 9.30 9.30               8.56 8.56 8.56                 7.71 7.71                   6.73

Swaps (5-year)Floating rate

Page 15: Liability management at GM

Cash Flows From SWAP 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 Total                   - 7.49 - 43.17                 - 6.51 - 6.51 - 35.65               - 5.66 - 5.66 - 5.66 - 29.12             - 4.92 - 4.92 - 4.92 - 4.92 - 23.44           - 4.28 - 4.28 - 4.28 - 4.28 - 4.28 - 18.50         - 3.72 - 3.72 - 3.72 - 3.72 - 3.72 - 3.72 - 14.20       - 3.23 - 3.23 - 3.23 - 3.23 - 3.23 - 3.23 - 3.23 - 10.47     - 2.80 - 2.80 - 2.80 - 2.80 - 2.80 - 2.80 - 2.80 - 2.80 - 7.22   - 2.44 - 2.44 - 2.44 - 2.44 - 2.44 - 2.44 - 2.44 - 2.44 - 2.44 - 4.39 - 2.12 - 2.12 - 2.12 - 2.12 - 2.12 - 2.12 - 2.12 - 2.12 - 2.12 - 2.12 - 1.94 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.20 2.16 2.16 2.16 2.16 2.16 2.16 2.16 2.16 2.16 2.16 2.34   2.48 2.48 2.48 2.48 2.48 2.48 2.48 2.48 2.48 4.79     2.84 2.84 2.84 2.84 2.84 2.84 2.84 2.84 7.62       3.27 3.27 3.27 3.27 3.27 3.27 3.27 10.87         3.76 3.76 3.76 3.76 3.76 3.76 14.60           4.32 4.32 4.32 4.32 4.32 18.90             4.96 4.96 4.96 4.96 23.84               5.70 5.70 5.70 29.52                 6.55 6.55 36.05                   7.53 43.57

Swaps (5-year)Difference between Fixed and Floating

Page 16: Liability management at GM

Swaps (5-year)Net Cash Flows (Bond + SWAP)  

- 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 NPV IRR                    - 422.74 0.00 10.04%                  - 21.76 - 421.76 0.00 9.65%                - 20.91 - 20.91 - 420.91 0.00 9.31%              - 20.17 - 20.17 - 20.17 - 420.17 0.00 9.02%            -19.53 - 19.53 - 19.53 - 19.53 - 419.53 0.00 8.77%          -18.97 -18.97 - 18.97 - 18.97 - 18.97 - 418.97 0.00 8.56%        -18.48 -18.48 -18.48 - 18.48 - 18.48 - 18.48 - 418.48 0.00 8.38%      -18.05 -18.05 -18.05 -18.05 - 18.05 - 18.05 - 18.05 - 418.05 0.00 8.23%    -17.69 -17.69 -17.69 -17.69 -17.69 - 17.69 - 17.69 - 17.69 - 417.69 0.00 8.10%  -17.37 -17.37 -17.37 -17.37 -17.37 -17.37 - 17.37 - 17.37 - 17.37 - 417.37 0.00 7.98% 397.93 -15.23 -15.23 -15.23 -15.23 -15.23 -15.23 - 15.23 - 15.23 - 15.23 - 415.23 0.00 7.89%  -13.09 -13.09 -13.09 -13.09 -13.09 -13.09 - 13.09 - 13.09 - 13.09 - 413.09 0.00 7.80%    -12.77 -12.77 -12.77 -12.77 -12.77 - 12.77 - 12.77 - 12.77 - 412.77 0.00 7.69%      -12.41 -12.41 -12.41 -12.41 - 12.41 - 12.41 - 12.41 - 412.41 0.00 7.55%        -11.98 -11.98 -11.98 - 11.98 - 11.98 - 11.98 - 411.98 0.00 7.40%          -11.49 -11.49 - 11.49 - 11.49 - 11.49 - 411.49 0.00 7.21%            -10.93 - 10.93 - 10.93 - 10.93 - 410.93 0.00 7.00%              - 10.29 - 10.29 - 10.29 - 410.29 0.00 6.75%                - 9.55 - 9.55 - 409.55 0.00 6.45%                  - 8.70 - 408.70 0.00 6.11%                    - 407.72 0.00 5.71%

For the 5-year swap, the 6-month LIBOR rates have to remain predominantly at 3.56% or lower

Page 17: Liability management at GM

Swaps (3-year)Net Cash Flows (Bond + SWAP)  

- 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 NPV IRR                    - 415.25 11.34 9.57%                  - 15.25 - 415.25 10.90 9.31%                - 15.25 - 15.25 - 415.25 10.52 9.09%              - 15.25 - 15.25 - 15.25 - 415.25 10.19 8.91%            -19.02 - 15.25 - 15.25 - 15.25 - 415.25 9.92 8.75%          -18.53 -18.53 - 15.25 - 15.25 - 15.25 - 415.25 9.69 8.62%        -18.10 -18.10 -18.10 - 15.25 - 15.25 - 15.25 - 415.25 9.49 8.51%      -17.72 -17.72 -17.72 -17.72 - 15.25 - 15.25 - 15.25 - 415.25 9.49 8.51%    -17.40 -17.40 -17.40 -17.40 -17.40 - 15.25 - 15.25 - 15.25 - 415.25 9.49 8.51%  -17.11 -17.11 -17.11 -17.11 -17.11 -17.11 - 15.25 - 15.25 - 15.25 - 415.25 9.49 8.51% 397.93 -15.23 -15.23 -15.23 -15.23 -15.23 -15.23 - 15.25 - 15.25 - 15.25 - 415.25 9.49 8.51%  -13.35 -13.35 -13.35 -13.35 -13.35 -13.35 - 15.25 - 15.25 - 15.25 - 415.25 9.49 8.51%    -13.06 -13.06 -13.06 -13.06 -13.06 - 15.25 - 15.25 - 15.25 - 415.25 9.49 8.51%      -12.74 -12.74 -12.74 -12.74 - 15.25 - 15.25 - 15.25 - 415.25 9.49 8.51%        -12.36 -12.36 -12.36 - 15.25 - 15.25 - 15.25 - 415.25 9.49 8.51%          -11.93 -11.93 - 15.25 - 15.25 - 15.25 - 415.25 9.29 8.40%            -11.44 - 15.25 - 15.25 - 15.25 - 415.25 9.05 8.27%              - 15.25 - 15.25 - 15.25 - 415.25 8.77 8.11%                - 15.25 - 15.25 - 415.25 8.43 7.93%                  - 15.25 - 415.25 8.04 7.72%                    - 415.25 7.56 7.47%

For the 3-year swap, the 6-month LIBOR rates would have to decline about 5% or more on a period-by-period basis from 3.60%.

Page 18: Liability management at GM

Swaps (2-year)Net Cash Flows (Bond + SWAP)  

- 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 NPV IRR                    - 415.25 13.45 9.18%                  - 15.25 - 415.25 12.81 8.98%                - 15.25 - 15.25 - 415.25 12.26 8.82%              - 15.25 - 15.25 - 15.25 - 415.25 11.81 8.68%            -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56%          -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56%        -17.37 -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56%      -17.04 -17.04 -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56%    -16.76 -16.76 -16.76 -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56%  -16.52 -16.52 -16.52 -16.52 -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56% 397.93 -14.89 -14.89 -14.89 -14.89 -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56%  -13.26 -13.26 -13.26 -13.26 -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56%    -13.02 -13.02 -13.02 -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56%      -12.74 -12.74 -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56%        -12.41 -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56%          -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56%            -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56%              - 15.25 - 15.25 - 15.25 - 415.25 11.03 8.44%                - 15.25 - 15.25 - 415.25 10.57 8.30%                  - 15.25 - 415.25 10.01 8.14%                    - 415.25 9.36 7.95%

The 2-year swap would not lower the cost of capital under all circumstances

Page 19: Liability management at GM

Swaps (Conclusion)

Current 6-month LIBOR rate: 4.31% Probability of LIBOR rates below 4%: ~ 0% Swap contracts - unsuitable for insulating GM’s cash flows and lowering its cost of capital

Page 20: Liability management at GM

Options on Treasury Notes

• Call option on 5-year treasury note

• Holder has the right to purchase $100 face value of treasury

notes at the end of 60 days at the strike price

• Seller receives a premium

5 year Treasury Note:      

Strike Price ($) Face Value ($) Premium For Bull Spread Yield

98.095 100 0.625 Buy 6.66%

99.045 100 0.328 Sell 6.46%

Page 21: Liability management at GM

Options on Treasury NotesCreate a bull spread using options on treasury notes

5 year Treasury Note:      Strike Price ($) Face Value ($) Premium For Bull Spread Yield

98.095 100 0.625 Buy 6.66%99.045 100 0.328 Sell 6.46%

95.00 98.10 99.05 100.00

-1.0000

-0.5000

-

0.5000

1.0000

1.5000

BuySellProfits

Page 22: Liability management at GM

Options on Treasury Notes

• If the price at maturity is above $98.40: reduce the cost of capital to a maximum of 7.88

• if the price is below $98.40: increase its cost of capital to a maximum of 7.92%.

BUT WHAT ABOUT MAKING MONEY FROM PREMIUMS???  

As we expect future yield rate to be high, most probably we will operate below our bull spread

           Strike Price @

MaturityFeb '92, 3 Mo T

rate (Rf) Premium On Maturity Total Profit

Buy Sell ($) ($)

100.000 3.80%- 0.629 0.330 0.950 0.651

99.045 3.80%- 0.629 0.330 0.950 0.651

98.095 3.80%- 0.629 0.330 - - 0.299

95.000 3.80%- 0.629 0.330 - - 0.299

Page 23: Liability management at GM

Options on Treasury Notes (Conclusion)• Long term yield curve would flatten (ie. Short term rates will

keep increasing)• Current yield of 5-year Treasury notes was 6.65%.• Long term yield rate to remain high above its current level -

supported by the banks’ forecast• Need at least a yield of 6.66% • Price at maturity would operate below the bull spread• Not a suitable instrument to control GM’s interest rate

exposure.

Page 24: Liability management at GM

Benchmark Caps• Sell an interest-rate cap

Type Maturity (yrs)Exercise

Price PremiumCap 5 9% 1.77% 2.13%Cap 5 10% 1.06% 1.42%

• GM gets a premium which would reduce cost of borrowing• GM obligated to pay any positive difference between LIBOR and rate cap• The cap with an exercise price of 9%:

• Premium - $8.52m; cost of capital - 7.37%• Cap with an exercise price of 10%:

• Premium - $5.68m; cost of capital - 7.54%

Page 25: Liability management at GM

Benchmark Caps Case 1: Write a Call at 9% exercise price      

LIBOR @ Maturity

Exercise Price

Feb '92, 3 Mo T

rate (Rf) Premium

On Maturity Total Profit

Buy Sell ($) ($)12% 9% 3.80%   8.531 - 12.000 - 3.47 10% 9% 3.80%   8.531 - 4.000 4.53 9% 9% 3.80%   8.531 - 8.53 7% 9% 3.80%   8.531 - 8.53

              Case 2: Write a Call at 10% exercise price (65-70% of the time LIBOR is under 10%) LIBOR @ Maturity

Exercise Price

Feb '92, 3 Mo T

rate (Rf) Premium

On Maturity Total Profit

Buy Sell ($) ($)12% 10% 3.80%   5.109 - 8.000 - 2.89 10% 10% 3.80%   5.109 - 5.11 9% 10% 3.80%   5.109 - 5.11 7% 10% 3.80%   5.109 - 5.11

Page 26: Liability management at GM

Benchmark Caps (Conclusion)• The probabilities of the caps not being exercised:

• 50% (for exercise price of 9%)• 65% (for exercise price of 10%)

• Selling a cap with exercise price of 10% would meet GM’s objectives about 65% of the time.

• Downside risk of unlimited losses at interest rates above 10% make it only a moderately attractive instrument

(esp. in the light of expected flattening of the yield curve

Page 27: Liability management at GM

Swaptions

Bond Issued Receive                      Pay                    

    Fixed Fixed Fixed

Fixed Fixed Fixed Fixed Fixed Fixed Fixed                                   Fixed Fixed Fixed Fixed Fixed Fixed

Swap Receive                      Pay                    

           

Floating Floating Floating Floating Floating Floating

Exercise period Maturity of swap Fixed rate Premium (in basis point)

2 years (2 by 5) 3 yrs 9% 89 – 108

3 years (3 by 5) 2 yrs 9% 94 – 111

• An option to enter into an interest-rate swap

Page 28: Liability management at GM

Swaptions (2 by 5)  Years To Maturity    

Corporate AA Borrowers

  1 2 3 4 5 7 10 20    

Now 4.95% 5.75% 6.42% 6.98% 7.33% 7.67% 8.00% 8.45%   Forward years 1 6.55% 7.16% 7.66% 7.93% 7.98% 8.15% 8.36% 8.67%   Forward years 2 7.77% 8.22% 8.39% 8.34% 8.37% 8.48% 8.56% 8.82%   

Annual Forward rate       8.73% 8.19% 8.49%          6 months Forward rate       4.37% 4.10% 4.25%          LIBOR at discount to AA       0.90% 0.90% 0.90%          6 Months LIBOR rate       3.46% 3.19% 3.34%                                 CASE 1: On 6 Month LIBOR RATE                  

($ Mn) - 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 Net Cash Flow from Bonds 397.93 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 415.25 Fixed Rate SWAP payments received - - - - - - - - - - - Premium on writing the call 3.56                     Floating rate payed - - - - - - - - - - - Total 401.49 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 415.25 NPV of Cash Flows 401.49 - 14.70 - 14.16 - 13.65 - 13.15 - 12.68 - 12.22 - 11.77 - 11.34 - 10.93 - 286.89 Sum of NPVs - 0.00                     Yield Rate 7.68%                    

Page 29: Liability management at GM

Swaptions (2 by 5) CASE 2: LIBOR rate at which GM will be indifferent            

($ Mn) -

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00 Net Cash Flow from Bonds

397.93

- 15.25

- 15.25

- 15.25

- 15.25

- 15.25

- 15.25

- 15.25

- 15.25

- 15.25

- 415.25

Fixed Rate SWAP payments received

-

-

-

-

-

18.00

18.00

18.00

18.00

18.00

18.00

Premium on writing the call

3.56                    

Indifference 6 Mo LIBOR rate           4.70%         

Floating rate payed -

-

-

-

-

- 18.78

- 18.78

- 18.78

- 18.78

- 18.78

- 18.78

Total 401.49

- 15.25

- 15.25

- 15.25

- 15.25

- 16.03

- 16.03

- 16.03

- 16.03

- 16.03

- 416.03

NPV of Cash Flows 401.49

- 14.68

- 14.13

- 13.61

- 13.10

- 13.26

- 12.76

- 12.28

- 11.83

- 11.39

- 284.46

Sum of NPVs 0.00                    

Yield Rate 7.90%                   

Page 30: Liability management at GM

Swaptions (3 by 5)  Years To Maturity    

Corporate AA Borrowers

  1 2 3 4 5 7 10 20    

Now 4.95% 5.75% 6.42% 6.98% 7.33% 7.67% 8.00% 8.45%   Forward years 1 6.55% 7.16% 7.66% 7.93% 7.98% 8.15% 8.36% 8.67%   Forward years 3 8.67% 8.70% 8.54% 8.52% 8.55% 8.68% 8.65% 8.91%   

Annual Forward rate         8.46% 8.67%          6 months Forward rate         4.23% 4.34%          LIBOR at discount to AA         0.90% 0.90%          6 Months LIBOR rate         3.33% 3.43%                                 CASE 1: On 6 Month LIBOR RATE                  

($ Mn) - 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 Net Cash Flow from Bonds 397.93 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 415.25 Fixed Rate SWAP payments received - - - - - - - - - - - Premium on writing the call 3.76                     Floating rate payed - - - - - - - - - - - Total 401.69 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 415.25 NPV of Cash Flows 401.69 - 14.70 - 14.16 - 13.65 - 13.16 - 12.68 - 12.22 - 11.78 - 11.35 - 10.94 - 287.05 Sum of NPVs 0.00                     Yield Rate 7.66%                    

Page 31: Liability management at GM

Swaptions (3 by 5) CASE 2: LIBOR rate at which GM will be indifferent              

($ Mn) -

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00 Net Cash Flow from Bonds

397.93

- 15.25

- 15.25

- 15.25

- 15.25

- 15.25

- 15.25

- 15.25

- 15.25

- 15.25

- 415.25

Fixed Rate SWAP payments received

-

-

-

-

-

-

-

18.00

18.00

18.00

18.00

Premium on writing the call

3.76                    

Indifference 6 Mo LIBOR rate               4.82%      Floating rate payed

-

-

-

-

-

-

-

- 19.28

- 19.28

- 19.28

- 19.28

Total 401.69

- 15.25

- 15.25

- 15.25

- 15.25

- 15.25

- 15.25

- 16.53

- 16.53

- 16.53

- 416.53

NPV of Cash Flows

401.69

- 14.68

- 14.13

- 13.61

- 13.10

- 12.61

- 12.14

- 12.67

- 12.20

- 11.74

- 284.81

Sum of NPVs 0.00                    

Yield Rate 7.90%                    

Page 32: Liability management at GM

Swaptions (Conclusion)• 2-by-5 swaption: Premium - $3.56m; Cost of capital - 7.68%

• 3-by-5 swaptions: Premium - $3.76m; Cost of capital - 7.66%.

• The threshold 6-month LIBOR rates:

• 4.7% (for 2-by-5)

• 4.82% (for 3-by-5)

• Probabilities of making a loss: 40% - 45%

• Plausible instruments BUT

• Downside risk of unlimited losses at interest rates above

9.4%/9.64%

• Only moderately attractive instrument

Page 33: Liability management at GM

Recommendation• Core principle for risk management

- To reduce the variability of GM’s cash flows and lower its expected costs of financial distress

• Timing the market to reduce their cost of capital - Grey area between hedging and speculation

Recommendation: • To issue the $400m note without any accompanying derivative

• Doing nothing meets the core objective of hedging (ie. insulating its cash flow from interest rate risk).

• All other alternatives increase the variability of cash flows and serve more towards the objective of lowering the cost of debt

• Explore the possibility of issuing a recallable note instead of a plain vanilla one.

Page 34: Liability management at GM

Suggested Improvement to GM’s programme

• Consolidation of the New York and Detroit Office to reduce duplication of work and could better maximize the resources.• Clear guidelines for the various offices

• Treasurer’s office to set financial targets

• Liability management program should be less speculative in nature.• Counterparty exposure:

• By hedging large sums of debt involves exposure to multiple parties thereby increasing the counterparty risk.