BUS 410- D200

Honda Motor Co. Ltd.

FX Risk
By:

Derek Chiu (301069850)

Eva Kwai (301049143)

Hugo Cho (301029435)

Jennifer Jan (301068026)

Date: March 27, 2011

Introduction
Honda Motor Co. Ltd. is the fifth largest car manufacturer and the largest motorcycle maker worldwide
(Wikinvest, 2010). Established in 1948, it continues to create new value and provide products of the
highest quality at a reasonable price to meet customer satisfaction. With over 390 subsidiaries and 102
affiliates internationally (Annual Report, 2010), Honda’s revenue and expenses are recorded in a
variety of different currencies. However, the major problem with using numerous currencies is the
volatility that is associated with the foreign exchange rates. Consequently, Honda must try to minimize
its exposure to any potential instability that may occur with the uncertainty of the markets. For
example, Honda’s foreign manufacturing plants can become more or less profitable overnight in the
event of an abrupt change in the currency. This could make Honda’s operations unprofitable for
reasons out of its control. In this paper we will be examining the foreign exchange risks and the
preventative measures Honda utilizes. These consist of several derivative financial instruments
including the use of currency swaps, forward agreements and option contracts.
Purpose of Hedging
As Honda’s foreign operations contribute over 77% of its total operating income in 2010 as shown in
Appendix 1, it is vital that Honda maintains a steady exchange rate between foreign currencies and the
Yen. Without hedging the foreign exchange rate, Honda’s large account receivables may suffer
dramatically if the currency of each country depreciates against the Yen. In other words, this would
mean the revenue generated by those countries is worth less when converted back to Yen. In 2010,
almost 67% of the total operating income is from North America alone, as indicated in Appendix 1,
which is generated mainly by the US. If the US dollar depreciates against the Yen, this would have a
significant impact on Honda’s revenue when repatriated. However, since Honda has hedged against
the US dollar, any steep decrease in the exchange rate would be limited as it caps the falling rate at a
certain level to prevent further depreciation.
The appreciation of a currency may also have detrimental effects for Honda if the country of that
currency has higher costs than revenues. As indicated in Appendix 2, Europe reported an operating loss
in 2010 which meant that costs were higher than its revenue. If the Euro was to appreciate against the
Yen, it would increase the cost for Honda as they would have to supply more Yen to pay off the costs
and would further reduce their overall operating income. By hedging the Euro, Honda can limit the rise
of their costs to a fixed level lower than if they were otherwise not hedged.
Even though the cost of hedging is high, Honda’s main objective and concern is to prevent the
fluctuations in the foreign exchange rate from affecting its operations. Thus, hedging activities used by
Honda allows for stability and predictability of its finances from its global business.
Tools for Hedging
Honda uses forward contracts as their primary hedging tools. By using forward contracts, Honda can
accurately determine their exchange rate at a future date. As indicated in Appendix 3, Honda mainly
buy and sell forward contracts in US dollars, Canadian dollars, Euro and British pounds as these four
regions generate the most profits and these currencies have the greatest effect on Honda’s operating
income.
Honda also use zero cost collars as a secondary tool to provide complete protection against the extreme
depreciation of a currency beyond a certain level. However, in doing so Honda must give up potential
benefits above a certain point. This process also allows for zero transaction costs since it is buying and
selling an option at the same time, thus eliminating the cost of the premium. As shown in Appendix 3,
Honda is mostly focused on the U.S currency for zero cost collars. However, when comparing the
contract amounts in 2010, zero cost collars were used significantly less than forward contracts. This is
due to forward contracts give higher certainty than zero cost collars.
Forecasting
In order to determine the amount of forward and option contracts to purchase, Honda forecasts its sales
revenue based on its previous year’s number. Yet, not all forecasts are accurate Based on 2007’s
operating income in Europe market, Honda forecasted a decrease in operating income in the Europe
market in 2008(Kageyama, 2008). Thus, in 2008 they purchased less forward contracts of selling the
Euro in 2009 compared to 2008 as shown in. However, as shown in Appendix 4, the operating income
in 2008 actually increased instead of decreased. Even though the contract amounts differed over the
past five years and the majority were losses, Honda consistently used the same hedging techniques and
continued to focus on the four major currencies. Appendix 3 shows that only in 2008 did they manage
to make a profit by using the forward contracts over the past five years. However, they still continued
use forward contracts as their primary hedging tool.
Hedging Analysis

For the past six years, the North American region sold on average 46% 1 of the total units of cars
produced in each year. Their revenue on average is 41%* of the total revenue which is also the highest
according to Appendix 5. This region also contributed on average 40%* of the cost compared to the rest
of the regions which is demonstrated in Appendix 6. The reason the cost is the highest is due to four of
the eight production sites are located in North America. Overall Honda still has a high operating
income in North America market as indicated by Appendix 7. On average, 53%* of Honda’s total
operating income is from the North American segment as shown in Appendix 10. Therefore, profit
from this segment is then converted back to Yen as any adverse currency changes would potentially
harm Honda’s total operating income therefore it has a great need for selling U.S. currency forwards.

Conclusion
It is easy to understand why a large multinational corporation with operations in several currency zones
must be fiscally prudent. However, for the past six years Honda has used the exact same hedging
system which shows a pattern of risk aversion that has lead to an overly cautious approach to its U.S
currency hedging. By going for a modest forward rate Honda has suffered losses in potential revenues.
Hence, Honda’s decision to ensure a predictable cash flow by locking into a conservative rate has
carried significant opportunity costs. Thus, it is clear that Honda values certainty above potential
profitability in the notoriously volatile international currency markets.

1
The number is the average of the sum of units sold from year 2005-2010 in Appendix 9
*
The numbers are the average of the sum of revenue, cost, and operating income from year 2005- 2010 financial
statements in Appendix 10
 Appendices

Appendix 1- Operating Income Proportions from Foreign Countries (Data Retrieved from Annual
Report)
Fiscal years ended March 31,
2008 2009 2010
Units Revenue Units Revenue Units Revenue
(thousands) (billions) (thousands) (billions) (thousands) (billions)
Japan 615 ¥1,321.0 556 ¥1,225.3 646 ¥1,383.8
North America 1,850 5,209.4 1,496 3,723.8 1,297 3,013.4
Europe 391 1,182.6 350 923.5 249 575.3
Asia 755 1,048.4 793 1,079.5 950 1,041.2
Other Regions 314 727.8 322 721.9 250 540.9
Total 3,925 ¥9,489.3 3,517 ¥7,674.4 3,392 ¥6,554.8
Automobile revenue as a percentage of total sales
revenue 79% 77% 77%

Appendix 2- 2010 Operating Income from Different Regions (Data Retrieved from Annual Report)
As of and for the year ended March 31, 2010
Yen (millions)
North Other Reconciling
Japan America Europe Asia Regions Total Items Consolidated
Net sales and other operating revenue:
External customers ¥1,864,513 ¥3,752,417 ¥769,857 ¥1,320,047 ¥872,340 ¥ 8,579,174 ¥ — ¥ 8,579,174
Transfers between geographic areas 1,441,264 155,799 55,615 198,533 24,151 1,875,362 (1,875,362) —
Total ¥3,305,777 ¥3,908,216 ¥825,472 ¥1,518,580 ¥896,491 ¥10,454,536 ¥ (1,875,362) ¥ 8,579,174
Cost of sales, SG&A and R&D expenses 3,334,912 3,671,837 836,344 1,405,574 850,683 10,099,350 (1,883,951) 8,215,399
Operating income (loss) ¥ (29,135) ¥ 236,379 ¥ (10,872) ¥ 113,006 ¥ 45,808 ¥ 355,186 ¥ 8,589 ¥ 363,775
Assets ¥2,947,764 ¥6,319,896 ¥591,423 ¥1,050,727 ¥619,345 ¥11,529,155 ¥ 99,960 ¥ 11,629,115
Long-lived assets ¥1,113,386 ¥1,861,596 ¥107,262 ¥ 240,704 ¥162,198 ¥ 3,485,146 ¥ — ¥ 3,485,146

Appendix 3- Honda Forward Contracts and Option Currency Contracts (Data Retrieved from Annual
Report)
Foreign Exchange Risk
2009 2010
Yen (millions) Average Yen (millions) Average
Contract contractual Contract contractual
Forward Exchange Contracts amount Fair value rate amount Fair value rate
To sell US$ ¥182,941 (8,966) 93.33 ¥257,822 (6,076) 90.80
To sell EUR 42,324 (2,086) 123.40 32,188 456 126.70
To sell CA$ 379 (5) 76.99 24 57 88.58
To sell GBP 49,681 (2,673) 133.42 29,931 (108) 139.69
To sell other foreign currencies 16,549 (387) various 20,761 (829) various
To buy US$ 3,287 131 94.26 3,207 102 90.02
To buy other foreign currencies 1,933 (11) various 3,537 34 various
Cross-currencies 234,521 94 various 231,657 (1,134) various
Total ¥531,615 (13,903) ¥579,127 (7,498)

Yen (millions) Average Yen (millions) Average

 Contract contractual Contract contractual
Currency Option Contracts amount Fair value rate amount Fair value rate
Option purchased to sell US$ ¥24,548 304 various ¥27,865 78 various
Option written to sell US$ 51,551 (1,743) various 55,731 (829) various
Option purchased to sell other currencies — — — 3,123 (50) various
Option written to sell other currencies — — — 6,246 (26) various
Total ¥76,099 (1,439) ¥92,965 (827)

Appendix 4- Euro Operating Income VS Forward Contracts Purchased (Data Retrieved from Annual
Report)

EUR Operating Income Vs. Forwards

140,000
120,000
100,000
80,000
Operating income
60,000 Sell EUR Forward
40,000
20,000
0
-20,000 2005 2006 2007 2008 2009 2010

Appendix 5- Yearly Revenue by Regions (Data Retrieved from Annual Report)

Revenue (in million Yen)

7,000,000

6,000,000

5,000,000
Japan
4,000,000 North America

3,000,000 Europe
Asia
2,000,000
Other Regions
1,000,000

0
2005 2006 2007 2008 2009 2010
Appendix 6- Yearly Expenses by Regions (Data Retrieved from Annual Report)

Expense (in million Yen)

6,000,000

5,000,000

4,000,000 Japan
North America
3,000,000
Europe
Asia
2,000,000
Other Regions

1,000,000

0
2005 2006 2007 2008 2009 2010

Appendix 7- Yearly Operating Income by Regions (Data Retrieved from Annual Report)

Operating Income (in million Yen)

500,000

400,000

300,000 Japan
North America
200,000
Europe
100,000 Asia
Other Regions
0
2005 2006 2007 2008 2009 2010
-100,000

-200,000
Appendix 8- 2010 Operating Income Proportions of Different Regions (Data Retrieved from Annual
Report)

2010
Japan North America Europe Asia Other Regions

11% -7%

26%

54%

-2%

Appendix 9- 2005-2010 Units Sold by Regions (Data Retrieved from Annual Report)

Fiscal years ended March 31,

2007 2008 2009
Units Revenue Units Revenue Units Revenue
(thousands) (billions) (thousands) (billions) (thousands) (billions)
Japan 337 ¥ 101.7 311 ¥ 93.5 232 ¥ 81.8
North America 503 308.2 453 265.6 320 182.2
Europe 329 219.7 313 226.6 276 178.6
Asia 7,895 383.3 6,633 484.4 7,523 460.4
Other Regions 1,305 357.4 1,610 488.3 1,763 508.3
Total 10,369 ¥1,370.6 9,320 ¥1,558.6 10,114 ¥1,411.5
Motorcycle revenue as a percentage of total sales
revenue 12% 13% 14%
Appendix 10- 2005-2010 Cost, Operating Income and, Revenue Statements by Regions (Data
Retrieved from Annual Report)
As of and for the year ended March 31, 2005
Yen (millions)
North Other Reconciling
Japan America Europe Asia Regions Total Items Consolidated
Net sales and other operating revenue:
External customers ¥1,983,182 ¥4,585,650 ¥ 858,936 ¥773,753 ¥448,584 ¥ 8,650,105 — ¥ 8,650,105
Transfers between geographic areas ¥2,155,756 ¥ 119,904 ¥ 184,136 ¥ 86,810 ¥ 17,373 ¥ 2,563,979 ¥ (2,563,979) —
Total ¥4,138,938 ¥4,705,554 ¥1,043,072 ¥860,563 ¥465,957 ¥11,214,084 ¥ (2,563,979) ¥ 8,650,105
Cost of sales,
SG&A and R&D expenses ¥3,954,039 ¥4,384,400 ¥1,001,829 ¥799,871 ¥432,764 ¥10,572,903 ¥ (2,553,718) ¥ 8,019,185
Gain on transfer of the substitutional portion of
the Employees’ Pension Funds — — — — — — — —
Operating income ¥ 184,899 ¥ 321,154 ¥ 41,243 ¥ 60,692 ¥ 33,193 ¥ 641,181 ¥ (10,261) ¥ 630,920
Assets ¥2,480,052 ¥5,254,246 ¥ 649,547 ¥541,331 ¥203,605 ¥ 9,128,781 ¥ 239,455 ¥ 9,368,236
Long-lived assets ¥ 894,065 ¥ 502,284 ¥ 118,339 ¥121,095 ¥ 47,429 ¥ 1,683,212 — ¥ 1,683,212

As of and for the year ended March 31, 2006

Yen
(millions)
North Other Reconciling
Japan America Europe Asia Regions Total Items Consolidated
Net sales and other operating revenue:
External customers ¥2,021,999 ¥5,475,261 ¥1,001,177 ¥ 856,892 ¥552,667 ¥ 9,907,996 — ¥ 9,907,996
Transfers between geographic areas ¥2,415,874 ¥ 141,064 ¥ 188,341 ¥ 140,501 ¥ 19,023 ¥ 2,904,803 ¥ (2,904,803) —
Total ¥4,437,873 ¥5,616,325 ¥1,189,518 ¥ 997,393 ¥571,690 ¥12,812,799 ¥ (2,904,803) ¥ 9,907,996
Cost of sales,
SG&A and R&D expenses ¥4,204,939 ¥5,262,382 ¥1,163,213 ¥ 932,394 ¥514,527 ¥12,077,455 ¥ (2,900,348) ¥ 9,177,107
Gain on transfer of the substitutional portion
of the Employees’ Pension Funds ¥ 138,016 — — — — ¥ 138,016 — ¥ 138,016
Operating income ¥ 370,950 ¥ 353,943 ¥ 26,305 ¥ 64,999 ¥ 57,163 ¥ 873,360 ¥ (4,455) ¥ 868,905
Assets ¥2,695,212 ¥6,128,303 ¥ 800,786 ¥ 717,933 ¥309,209 ¥10,651,443 ¥ (20,043) ¥ 10,631,400
Long-lived assets ¥ 949,713 ¥ 589,596 ¥ 157,819 ¥ 167,148 ¥ 72,244 ¥ 1,936,520 — ¥ 1,936,520

As of and for the year ended March 31, 2007

Yen
(millions)
North Other Reconciling
Japan America Europe Asia Regions Total Items Consolidated
Net sales and other operating revenue:
External customers ¥2,061,720 ¥6,002,797 ¥1,228,564 ¥1,024,680 ¥769,379 ¥11,087,140 — ¥ 11,087,140
Transfers between geographic areas ¥2,712,403 ¥ 169,847 ¥ 119,161 ¥ 246,723 ¥ 28,259 ¥ 3,276,393 ¥ (3,276,393) —
Total ¥4,774,123 ¥6,172,644 ¥1,347,725 ¥1,271,403 ¥797,638 ¥14,363,533 ¥ (3,276,393) ¥ 11,087,140
Cost of sales,
SG&A and R&D expenses ¥4,545,988 ¥5,715,817 ¥1,315,736 ¥1,194,250 ¥725,377 ¥13,497,168 ¥ (3,261,907) ¥ 10,235,261
Gain on transfer of the substitutional portion
of the Employees’ Pension Funds — — — — — — — —
Operating income ¥ 228,135 ¥ 456,827 ¥ 31,989 ¥ 77,153 ¥ 72,261 ¥ 866,365 ¥ (14,486) ¥ 851,879
Assets ¥2,985,123 ¥6,834,409 ¥ 948,922 ¥ 935,963 ¥414,147 ¥12,118,564 ¥ (82,064) ¥ 12,036,500
Long-lived assets ¥ 993,078 ¥1,028,132 ¥ 198,232 ¥ 228,802 ¥ 93,485 ¥ 2,541,729 — ¥ 2,541,729
As of and for the year ended March 31, 2008
Yen (millions)
North Other Reconciling
Japan America Europe Asia Regions Total Items Consolidated
Net sales and other operating revenue:
External customers ¥2,053,401 ¥6,091,512 ¥1,502,240 ¥1,307,117 ¥1,048,564 ¥12,002,834 ¥ — ¥ 12,002,834
Transfers between geographic areas 2,835,639 173,751 91,983 331,173 44,253 3,476,799 (3,476,799) —
Total ¥4,889,040 ¥6,265,263 ¥1,594,223 ¥1,638,290 ¥1,092,817 ¥15,479,633 ¥ (3,476,799) ¥ 12,002,834
Cost of sales, SG&A and R&D expenses 4,696,482 5,832,635 1,542,676 1,507,566 976,335 14,555,694 (3,505,969) 11,049,725
Operating income ¥ 192,558 ¥ 432,628 ¥ 51,547 ¥ 130,724 ¥ 116,482 ¥ 923,939 ¥ 29,170 ¥ 953,109
Assets ¥3,127,143 ¥6,863,970 ¥ 948,544 ¥1,080,439 ¥ 574,890 ¥12,594,986 ¥ 20,557 ¥ 12,615,543
Long-lived assets ¥1,084,163 ¥1,589,356 ¥ 171,030 ¥ 260,141 ¥ 128,156 ¥ 3,232,846 ¥ — ¥ 3,232,846

As of and for the year ended March 31, 2009

Yen (millions)
North Other Reconciling
Japan America Europe Asia Regions Total Items Consolidated
Net sales and other operating revenue:
External customers ¥1,871,962 ¥4,534,684 ¥1,191,540 ¥1,335,091 ¥1,077,964 ¥10,011,241 ¥ — ¥ 10,011,241
Transfers between geographic areas 2,290,625 244,440 87,362 273,140 66,256 2,961,823 (2,961,823) —
Total ¥4,162,587 ¥4,779,124 ¥1,278,902 ¥1,608,231 ¥1,144,220 ¥12,973,064 ¥ (2,961,823) ¥ 10,011,241
Cost of sales, SG&A and R&D expenses 4,324,203 4,699,422 1,268,701 1,504,628 1,009,158 12,806,112 (2,984,514) 9,821,598
Operating income (loss) ¥ (161,616) ¥ 79,702 ¥ 10,201 ¥ 103,603 ¥ 135,062 ¥ 166,952 ¥ 22,691 ¥ 189,643
Assets ¥3,078,478 ¥6,547,880 ¥ 766,594 ¥1,016,059 ¥ 450,081 ¥11,859,092 ¥ (40,175) ¥ 11,818,917
Long-lived assets ¥1,140,316 ¥1,918,579 ¥ 110,543 ¥ 253,113 ¥ 119,373 ¥ 3,541,924 ¥ — ¥ 3,541,924

As of and for the year ended March 31, 2010

Yen (millions)
North Other Reconciling
Japan America Europe Asia Regions Total Items Consolidated
Net sales and other operating revenue:
External customers ¥1,864,513 ¥3,752,417 ¥769,857 ¥1,320,047 ¥872,340 ¥ 8,579,174 ¥ — ¥ 8,579,174
Transfers between geographic areas 1,441,264 155,799 55,615 198,533 24,151 1,875,362 (1,875,362) —
Total ¥3,305,777 ¥3,908,216 ¥825,472 ¥1,518,580 ¥896,491 ¥10,454,536 ¥ (1,875,362) ¥ 8,579,174
Cost of sales, SG&A and R&D expenses 3,334,912 3,671,837 836,344 1,405,574 850,683 10,099,350 (1,883,951) 8,215,399
Operating income (loss) ¥ (29,135) ¥ 236,379 ¥ (10,872) ¥ 113,006 ¥ 45,808 ¥ 355,186 ¥ 8,589 ¥ 363,775
Assets ¥2,947,764 ¥6,319,896 ¥591,423 ¥1,050,727 ¥619,345 ¥11,529,155 ¥ 99,960 ¥ 11,629,115
Long-lived assets ¥1,113,386 ¥1,861,596 ¥107,262 ¥ 240,704 ¥162,198 ¥ 3,485,146 ¥ — ¥ 3,485,146
 Reference List

Honda Annual Report (2005)

Honda Annual Report (2006)

Honda Annual Report (2007)

Honda Annual Report (2008)

Honda Annual Report (2009)

Honda Annual Report (2010)

Kageyama, Y. (2008 July, 25). Honda has Record Profit but Lowers Sales Forecast. USA Toda.
Retrieved from http://www.usatoday.com/money/companies/earnings/2008-07-25-honda_N.htm

Wikiinvest (2010)