BMW has a significant portion of operations outside Eurozone, mostly in the US and China

These include revenue, purchases, and funding from and within these regions. BMW is
exposed to currency risk due to these inter-currency transactions (BMW Annual Report, 2018
p. 99). The company classifies the currency risk as a component of principal market risk.
These are managed at the corporate level (BMW Annual Report, 2018, p. 176). The company
also has regional treasury offices in the UK, the US, and Singapore (Bin & Ying, 2012). The
base currency of the company is Euro which fluctuated in the band of 1.13 to 1.25 (€/$)
during FY 2018. It also fluctuated against GBP and appreciated against the majority of the
currencies like Chinese RMB, JPY, Russian Rouble and Brazilian real (BMW Annual
Report, 2018 p. 41, 86) (Appendix 1). Further, the four most important currencies for the
company vis GBP, JPY, RMB, and USD are expected to remain volatile in the next year.

The company uses a combination of currency risk management strategies at a strategic and
operational level. Strategic level techniques include long and medium-term measures while
operational level techniques are mostly short term driven. The total cost of hedging was €139
million (BMW Annual Report, 2018 p. 145, 170, 176). Further, the net financial instruments
covering the currency risk are €304 million and the extent of risk exposure and the
corresponding hedge ratio is decided at a regular interval. The measurement is done through a
cash-flow-at-risk model which is based on exposures. The currency exposure for 2018 was
€28,407. The approach shows the impact of currency fluctuation on the operating cash flows
of the company using probability distribution which is determined using volatilities and
correlation (Gentili, et al., 2018). The confidence level of 95% is used and the model arrives
at a cash flow at risk figure of €431 million for 2018 i.e. the potential loss due to currency
fluctuation (BMW Annual Report, 2018 p. 176).

Currency
Hedging
Techiniques

Operational
Strategic Level
Level

Hedging on
Natural Hedge
Financial Market

The company uses natural hedging as a measure to counter currency fluctuation that has a
long term effect (Zhao & Huchzermeier, 2018). Most of the revenue comes from exports, the
company has adopted a policy of producing and purchasing locally so that the cash inflows
and outflows maturing at the same date in that particular currency are netted. The company
matches its operating revenues with operating expenses and the net exchange rate effects are
canceled out. US and China are big markets for the company outside of the EU. The recent
trade war between the US and China has increased the cost of production in the US, the
Trumph administration has imposed a tariff of 25% on Chinese Steel (CNBC, 2019), which is
an essential raw material. Further, the depreciating RBM resulted in lesser revenue at the
same level of sale. However, the natural hedging technique helps the company counter these
adversaries. The US is a major sales region for BMW (14.2% share) (Statista, 2018), the
company is able to sell many cars there and the exchange difference is settled with the
revenue arising from the sale of cars. Further, the company has plant in China and it has plans
to boost its production (Sachgau, 2018). China is presently the biggest market (25.7% share)
(Statista, 2018). The company would be able to support high sales with more locally
produced cars than imported ones. Furthermore, the companies subsidiaries are located at all
of the major countries and it has a significant level of production and purchases locally in
those countries. Although, the net effect of natural hedging strategy will not be completely
eliminated as only the transactions of revenue nature are covered and by the end of a period
the surplus of sales over such expenses remain unhedged, still, the ultimate pressure is less on
the financial statements.

For the currency risks that can not be naturally hedged, the company uses short term
measures which include the use of derivative financial instruments including options (BMW
Annual Report, 2018 pp 126). Moreover, most of these are forward contracts (mainly) and
currency swaps (BMW Annual Report, 2018 pp176). Net gain from currency forward
contracts resulted at €336 million for 2017 (BMW Annual Report, 2018 pp180). The
company uses a model that is internally developed as a tool to plan forex hedging (Zhao &
Huchzermeier, 2018). This model identifies the currencies that are under and overvalued
based on the equilibrium rate determined by it. When the difference between the exchange
rates is more than the threshold limit the company adopts hedging strategy. The company
ideally goes for a forward contract for currencies to execute the strategy, however, sometimes
options strategy is also adopted. The company uses a combination of long and short to
completely hedge a position. Its cost is more than that of a forward contract but the
combination of long and short is a specific ratio ensures effectiveness and is less costly than
covered call strategy. The options are a good tool as they allow the company to gain upside
movements and hedge against downfalls but it is expensive at the same time.

The combination of the two strategies have long been followed by the company and are
proved to be effective for BMW. However, it must work on its internal model for the
betterment so that the cost of hedging can be minimized even more and the future risks are
mitigated.
References
‘Bin, X. & Ying, L.' 2012, in The case study: How BMW dealt with exchange rate risk,
Financialtimes.com, viewed 2 July 2019 < https://www.ft.com/content/f21b3a92-f907-11e1-
8d92-00144feabdc0>

BMW Annual Report 2018, BMW Annual Report, Munich: BMW.

'CNBC' 2019, in Trump increased his tariffs on China—here’s what they are and how they
work, CNBC.com, viewed 2 July 2019 <https://www.cnbc.com/2019/05/11/what-trumps-
tariffs-on-china-are-and-how-they-work.html>

Gentili, L, Giacomello, B, Girardi, D & Grasselli, M 2018, 'A Dynamic Model for Cash Flow
at Risk', Available at SSRN 3307255.

'Sachgau, O' 2018, in BMW Unveils Plan to Boost Production in China, bloomberg.com,
viewed 2 July 2019 <https://www.bloomberg.com/news/articles/2018-07-09/bmw-unveils-
plan-to-boost-production-in-china-amid-trade-war >

'Statista' 2018, in Breakdown of BMW Group's worldwide automobile sales in FY 2018, by

region, Statista.com, viewed 2 July 2019 <https://www.statista.com/statistics/267252/key-
automobile-markets-of-bmw-group/>

Zhao, L & Huchzermeier, A 2018, 'Capital Structure and Financial Risk Management',
Supply Chain Finance, pp. 21-38.
Appendix

Figure 1: Major currency exchange rates compared to the euro. Source: Reuters

Figure 2: Top countries buying BMW (Source: Statista, 2018)