IES204

2-207-002
Rev. 9/08

BMW: Currency Hedging 2007

The BMW Group continued to perform successfully in 2007 despite
difficult conditions, achieving record figures for sales volume and
revenues. External factors continued to affect figures adversely. The
ongoing weakness of the US dollar and the Japanese yen, the generally
high cost of raw materials and less favorable financing conditions all
continued to have a negative impact. This negative impact was increased
by costs of market launches for numerous new models. Group revenues
rose by 14.3% to €56,018 million, but they would have risen by an
additional 17.6% without the exchange rate impact. The company had
substantial US revenues, with over 25% of its sales taking place in US,
and, although the company had production facilities in North America,
local sales were higher than production resulting in an estimated positive
revenue exposure to the US dollar of US$ 7.4 billion.

The deterioration in the effective transaction rate for its US dollar-

denominated volumes when it came to conversion of its US dollar net
exposure to the Euro had an important impact on profitability. In 2007,
the clouding of exchange rates and the more expensive raw materials was
less of a burden when compared to the previous year. The deterioration of
foreign currency ratios put pressure on the result by €517 million in 2007,
compared to €666 million the previous year.

This case was prepared by María Oleaga, Research Assistant, under the supervision of Professor
José Manuel Campa, as the basis for class discussion rather than to illustrate either effective or
ineffective handling of an administrative situation. January 2007. Revised in September 2008.
This case was written with the support of the CIIF (International Center for Financial Research), IESE.

Copyright © 2007, IESE. To order copies or request permission to reproduce materials, contact IESE
PUBLISHING via the website, www.iesep.com. Alternatively, call +34 932 534 200, send a fax to
+34 932 534 343, or write IESEP, C/ Juan de Alós, 43 - 08034 Barcelona, Spain, or [email protected].
No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or
transmitted in any form or by any means – electronic, mechanical, photocopying, recording, or
otherwise – without the permission of IESE.

Last edited: 2/25/08

1

This document is authorized for use only in Gohar STEPANYAN's International Finance-1 course at EDHEC - Business School, from January 2017 to July 2017.
 IES204 BMW: Currency Hedging 2007

BMW’s own model for determining the “fair” exchange rate of the Euro and US dollar
formed the basis of BMW’s hedging strategy. This model derived at the end of the year
a fair FOREX range of 1.15 US$/€ to 1.17 US$/€. Only in the case of exchange rates
falling below this level would BMW hedge its currency exposure in the long-term and
to a considerable extent. In the case of less favorable rates, currency hedges will only
be made to a lesser and more short term extent. Next year’s earnings would vastly
depend on the upcoming dollar spot rate development.

The Company
Bayerische Motoren Werke (better known as BMW) was one of the world's ten largest
automobile manufacturers. The BMW Group covered the BMW, MINI and Rolls-Royce
brands, and it was the only automobile company worldwide to operate with all its
brands exclusively in the premium segments of the automobile market, from the small
car to the top of the segment.

The company was started by Karl Rapp in 1913 by opening an aircraft-engine design
shop near Munich. He named it Bayerische Motoren Werke (BMW) in 1917. The end of
WWI brought German aircraft production to a halt, and BMW shifted to making
railway brakes until the 1930s. In 1923, BMW produced its first motorcycle, the R32,
and the company began making automobiles in 1928 after buying Fahrzeugwerke
Eisenach, a manufacturer of small cars. In 1933 BMW launched a line of larger cars.

The company built aircraft engines for Hitler's Luftwaffe in the 1930s and stopped all
auto and motorcycle production in 1941 focusing its activities in aircraft and military
equipment. Under the Nazis, the company operated in occupied countries, built rockets,
and developed the world's first production jet engine. With its factories dismantled
after WWII, BMW survived by making kitchen and garden equipment.

In 1948 it began production of motorcycles again and introduced a one-cylinder

motorcycle, which sold well as cheap transportation in postwar Germany. It started
selling BMW cars again in the 1950s but its models were large and expensive and sold
poorly in postwar Germany.

The modern BMW started to be developed in 1959 when Herbert Quandt bought a
controlling stake for $1 million. Quandt focused BMW in the production of sports
sedans and released the first of the "New Range" of BMWs in 1961. The success of
these new products allowed the company to enter into a pattern of sustained growth.

In the 1970s BMW's European exports soared, and the company set up a distribution
subsidiary in the US. The company also started to produce larger cars that put it in
direct competition with the traditional market leader in the German luxury car
segment, Mercedes-Benz.

Rapid export growth in the US, Asia, and Australia continued in the 1980s. However,
this growth was not homogeneous. Competition from Japanese motorcycles hurt its
motorcycle sales. Furthermore, the launch of the company's new luxury vehicles in
1986 heated up the BMW-Mercedes rivalry at a time when Japanese car producers
were entering the US luxury market, and the dollar was reaching a maximum against
the German mark. US sales peaked that year and by 1991 had fallen by 45%.

2 IESE Business School-University of Navarra

This document is authorized for use only in Gohar STEPANYAN's International Finance-1 course at EDHEC - Business School, from January 2017 to July 2017.
 BMW: Currency Hedging 2007 IES204

However, BMW reacted aggressively and in 1992 BMW outsold Mercedes in Europe for
the first time and also became the first European car manufacturer to operate a US
plant, where it started to produce its new SUV the X5, since Volkswagen pulled out in
1988.

The 1990s was a decade of consolidation and growth through acquisitions. BMW
teamed with the UK's Rolls-Royce aerospace firm in 1990 to make jet engines for
planes. The company also bought UK car manufacturer Rover - with the brands Rover,
Land Rover, MINI and GM - from British Aerospace and Honda in 1994. Its goal was to
rejuvenate the existing models in these brands. BMW introduced a cheaper vehicle,
the four-wheel-drive Discovery and launched the Highlander Land Rover in 1996 to
meet a growing demand for 4x4 utility vehicles. In 1998, BMW offered to buy the
luxury Rolls-Royce auto unit (including the Bentley) from UK-based Vickers but lost
out to a higher offer by Volkswagen. The company did buy the Rolls-Royce auto brand
name and logo from aircraft engine maker Rolls-Royce for $66 million. (VW got to use
the name until 2003.)

BMW did not manage to successfully integrate all these acquisitions. In mid-1998
BMW began cutting jobs at its money-losing Rover unit and, as Rover's plants
continued their downward trend in 1999, BMW's board forced out its chairman Bernd
Pischetsrieder, who had spearheaded the Rover acquisition in 1994. As part of this
restructuring BMW threatened to move its UK operations to Hungary and the UK
government pledged to help pay for renovations at Rover's Longbridge plant to save
about 14,000 UK jobs that were in danger. The company finally sold its Land Rover
SUV operations to Ford in 2000 for about $2.7 billion. Also that year BMW handed
over its Rover Cars operations and MG brand to the Phoenix Consortium, a UK-based
group led by former Rover CEO John Towers although it retained the rights to the
Rover brand which it finally sold to Chinese carmaker Shanghai Automotive Industry
Corp (SAIC) for €11 million. in 2006.

In 2001 BMW launched its MINI brand in the UK, soon followed by its launch in other
European markets. BMW brought the MINI Cooper to US shores in 2002. The following
year BMW finally took control of the Rolls-Royce brand from Volkswagen, and began
making Rolls-Royce Phantoms in Goodwood in the south of England.

In India BMW Group rolled out its first locally-assembled 3 Series, the cheapest car
with the BMW badge, in March 2007. The company would also shortly start
assembling its 5 Series cars in India.

BMW Operations in 2007

The Group's activities were carried out through three business segments: Automobiles,
Financial Services and Motorcycles. The Automobile segment developed,
manufactured, assembled and sold BMW, Rolls-Royce and MINI brand cars, off-road
vehicles and spare parts and accessories. The Motorcycles segment developed,
manufactured, assembled and sold BMW brand motorcycles, as well as spare parts and
accessories. Finally, the Financial Services segment focused on leasing automobiles,
and providing insurance products and loan finance for customers and dealers.

IESE Business School-University of Navarra 3

This document is authorized for use only in Gohar STEPANYAN's International Finance-1 course at EDHEC - Business School, from January 2017 to July 2017.
 IES204 BMW: Currency Hedging 2007

As an international corporation, the BMW Group had 23 production and assembly

plants distributed among 12 countries worldwide. The production network covered
seven plants for BMW automobiles located in four countries (Germany, USA, South
Africa and China) and one plant for BMW motorcycles in Germany. In Great Britain,
the BMW Group had a plant for production of MINI vehicles in Oxford and a head
office and a manufacturing plant for Rolls-Royce automobiles in Goodwood. The
Group also operated four production sites for components and three engine plants in
Germany, Austria and Great Britain. . A fourth engine plant, TRITEC Motors Ltda., was
operated as a joint venture with DaimlerChrysler in Brazil. Additionally Magna Steyr
AG & Co KG is producing the BMW X3 in Graz, Austria for the BMW Group. The
company had eight assembly plants (Completely-Knocked-Down) for BMW
automobiles in Thailand, Egypt, Indonesia, Malaysia and Russia. These plants were
mainly operated in cooperation with external partners.

BMW's car range includes sedans, coupes, convertibles, and sport wagons in the
3 Series, 5 Series, 6 Series, and 7 Series model groups. Other models include the M3
coupe and convertible; the X5 sport utilities; and the Z4 roadster. In addition to its
BMW automobiles, the company's operations include the MINI automotive brand and
Rolls-Royce Motor Cars. Its motorcycle production includes models (K 1200 GT, R 1200
GS, and R 1150 R models, among others), and software (softlab GmbH). BMW's
motorcycle division also offers a line of motorcycling apparel such as leather suits,
gloves, and boots.

Within the framework of its sales strategy, the BMW Group had, since the 1970s, been
consistently pursuing its objective of having its own sales subsidiaries in all major
markets. Today, the sales network consists of 34 group-owned sales companies and
around 3,000 dealerships. Smaller markets are served via importers. This means that
the BMW Group is represented in over 150 countries on all five continents.

Company Performance
In 2007 group revenues rose by 14.3% to €56,018 million, due to strong sales volume
growth. Excluding the exchange rate impact, revenues would have risen by 17.6%. The
BMW Group profit before tax, at €3,873 million, was 6.1% below the record level
achieved in the previous year. Excluding the effect of the settlement of the
exchangeable bond on shares in Rolls-Royce plc, London, pre-tax earnings were, as
forecasted, slightly above the previous year’s level. The company was ahead of a
consolidation phase of its major product launch phase which began in 2004,
expanding its product range by introducing various new models such as the 1 Series,
the 6 Series and the X3, BMW X5, X6 and MINI. No model turned out to be a miss and
all launches met or exceeded expectations. The Group registered new sales volume
records in 2007 for all three brands. In total, 1,500,678 BMW, MINI and Rolls-Royce
brand cars were sold during 2007, an increase of 9.2% compared to the previous year.

Revenues of the Automobile segment in 2007 amounted to €53,818 million, rising

therefore by 12.7% compared to the previous year. Despite the impact of adverse
foreign exchange rates and high raw material prices, this segment reported a profit
before tax of €3,232 million, 7.3% up from the previous year. The Motorcycles
business revenues fell short of the previous year, dropping to €1,228 million (-2.9%).

4 IESE Business School-University of Navarra

This document is authorized for use only in Gohar STEPANYAN's International Finance-1 course at EDHEC - Business School, from January 2017 to July 2017.
 BMW: Currency Hedging 2007 IES204

However process optimization and efficiency improvement programs implemented in

the past continued to have a positive impact, enabling the segment to increase its profit
before tax by 7.6% to €71 million. The Financial services business continued to grow at an
extremely dynamic pace, with revenues rising by 25.8% to €13,940 million. This strong
growth is reflected in the segment profit before tax which, at €743 million, was 8.5% up
on the previous year. See Exhibits 1 and 2.

The profit before financial results increased by €162 million (4.0%) against the
previous year and therefore reached a new high level. The financial result deteriorated
by €413 million. Earnings in 2006 included a gain of €372 million resulting from the
partial settlement of the exchangeable bond on shares in Rolls-Royce plc, London.
Further conversions in 2007 gave rise to a gain of €97 million. The bond was
completely settled by the end of 2007. In addition to the gain on the exchangeable
bond, other financial results also include losses on other derivative financial
instruments, in particular stand-alone interest-rate derivatives. A changed market
interest rate structure caused the fair values of these financial instruments to decrease.
For these reasons the BMW Group profit before tax, at €3,873 million, was 6.1% below
the record level achieved in the previous year

Business tax reform in Germany had a positive impact on earnings, reducing the tax
expense sharply. The effective tax rate for 2007 fell to 19.1% from 30.3% in 2006. So
the Group’s net profit of €3,134 million reached a new high level, surpassing the
previous year’s figure by 9%. See Exhibit 3 for Group Balance Sheet and Income
Statement.

High raw materials costs, currency fluctuations and intense global competition in
international markets were adverse factors for the performance of the company. Oil
prices, a basic element in the automotive industry, rose sharply in 2007, largely due to
persisting shortages in oil production and processing capacities, at a time when
demand continued to rise steeply. Oil prices were also pushed up by natural
catastrophes, which impaired production and processing capacities, and by a higher
than usual level of speculation, a factor which always tends to have a greater impact
on prices during times of shortage. The price for one barrel of Brent Crude at the end
of 2007 was US$ 94.33, 61.2% above its level one year earlier.

The price of steel also exceeded the level of the previous year. This was also largely
due to an increase in demand from the emerging markets. The prices of most precious
metals have been rising continually for several years and this trend continued in 2007.
Apart from the increasing demand, the loss in value of the US dollar has created an
additional demand for precious metals and investments, mainly in the emerging
markets. See Exhibit 4 for evolution of raw material prices.

High oil prices increased costs for plastics. This coupled with the large increase in steel
prices caused an increase in costs of goods sold. To offset these conditions, BMW was
working closely with its suppliers to lower the cost of components while keeping
innovation and quality high. Despite this increase in costs, BMW still generated the
best margins within its western auto manufacturers peer group (excluding Porsche). A
comparison of BMW EBIT margins with its peer group highlights the company’s
performance in recent years. The EBIT margin of BMW at 7.5% was 2% above the

IESE Business School-University of Navarra 5

This document is authorized for use only in Gohar STEPANYAN's International Finance-1 course at EDHEC - Business School, from January 2017 to July 2017.
 IES204 BMW: Currency Hedging 2007

average of the four largest European producers. See Exhibit 5, BMW and main
automobile competitors.

The US dollar continued to lose value over the course of 2007. After standing at 1.32
US$/€ in January, it closed the year almost 10% weaker at 1.46 US$/€. In November 2007,
the US dollar even dropped to 1.50 US$/€, reaching its record low value since the
introduction of the common European currency in 2002.

In 2007, the British Pound was slightly more volatile than in previous years. It lost
value during the year, finishing at around 0.73 £/€. After a phase of gaining in value,
the yen lost in value against the euro from the middle of the year onwards, and closed
at 164 ¥/€, some 4.5% lower than one year earlier. This is at odds with the relevant
fundamental data since the Japanese economy has recovered from its recession and
promises to deliver more solid growth than the euro region. See Exhibit 6.

BMW had a net export exposure to the US dollar. The US was a large market with
revenues of US$ 11.5 billion according to Deutsche Bank´s estimation. BMW had only
one operating plant in the US in Spartanburg (South Carolina), which it had
established at the beginning of the 1990s and it had been producing the X5, the Z4,
and some of the X6 models. Operating costs in this plant were estimated to amount to
approximately US$ 3.5 billion, leaving BMW with an estimated net dollar exposure of
almost US$ 7.4 billion. See Exhibit 7 for estimated net revenue exposure (dollar based)
2008e-2009e.

BMW is focusing on natural hedging in order to decrease US dollar exposure.

According to BMW's chief executive, BMW will increase the production capacities in
the US plant from 150,000 units in 2007 to 240,000 units in 2010, but at the same
time the purchases made in the dollar zone are increasing. In fact they rose over 16%
in the year 2007.

The company was well aware of the impact that these adverse movements in raw
materials and exchange rates were having on its overall performance. In 2007
revenues rose by 14.3% to €56,018 million, due to strong sales volume growth, but
excluding the exchange rate impact, revenues would have risen by 17.6% The
company had estimated the contribution that different factors had on earnings before
taxes (EBT). According to these estimates, the good performance in terms of volume
sales and prices had increased EBT by €1,419 million and efficiency gains had
contributed by 351 million. This increase offsets the negative side, increases in raw
materials that implied a 288 million decrease and adverse currency movements a
decline of 517 million, making the group profit before financial results rise by 4% to
€4,212 million . See Exhibit 8 for BMW walkdown of 2007 EBIT-Automobiles.

The company expected a similar effect for 2008 with adverse currency movements
again having the largest negative impact on EBT. The global automotive industry will
again be driven by the emerging economies of Asia, Eastern Europe and Latin America,
By contrast, the car markets in the USA, Japan and Western Europe are still not
generating any momentum. At best, the markets will stagnate. Car sales will decrease
slightly in the USA in the wake of the credit crisis. Japan is also unlikely to see any
significant upturn. This also applies to Western Europe taken as a whole. A slight
recovery is, however, forecast for Germany.

6 IESE Business School-University of Navarra

This document is authorized for use only in Gohar STEPANYAN's International Finance-1 course at EDHEC - Business School, from January 2017 to July 2017.
 BMW: Currency Hedging 2007 IES204

The American Economy and the Evolution of the Dollar

In the second half of the 1990s, the US stock market and other US equity returns
experienced a boom. Business investment rose dramatically, particularly on activities
related to information technologies. Low unemployment rates, growing wealth, and
optimistic assessments of future income led to increased consumer spending by
American households and lower savings rates, which dropped from 6.5% of GDP in
1992 to less than 1% in 2000. Rising stock prices drove up taxable income and
government savings, which helped to move the federal budget from a deficit of 4.8% of
GDP in 1992 to a surplus of 2.5% in 2000. But this was insufficient to close the
widening gap between private investment and domestic private savings. This imbalance
between national savings and investment by the late 1990s led to a widening of the
current account deficit, although the budget deficit had moved into surplus.

At the same time, there was evidence of a “global savings glut” driven by demographic
factors. With slowly growing or declining workforces, many advanced economies
outside the US faced domestic investment opportunities. Foreign investors, attracted by
rapidly rising equity returns and productivity gains, chose to invest a portion of their
excess savings in the United States. Foreign capital inflows became focused on private
sector investments, so helping to finance the innovation and productivity growth of
the new economy.

With the creation of the euro currency in 1999 and contrary to predictions, the dollar
strengthened and the US current account deficit continued to widen. Between summer
1995 and early 2002 the trade-weighted dollar appreciated in real terms by 34%. In
nominal terms, the dollar appreciated 53% against the euro and 12% against the
pound.

In 2000, the dot-com bubble burst, leading to a mild recession in the US between 2001
and 2002. The government responded with a fiscal stimulus in the form of a tax cut,
and the Federal Reserve responded with record-low interest rates, which led the federal
budget balance from a surplus of 2.4% in 2000 to a deficit of 3.5% in 2003. The US
current account deficit expanded from 4.2% of GDP in 2000 to 5.7% in 2004.

Funding of the US current account deficit was mainly performed by foreign central
banks. Between 2000 and 2004, all of the net new supply of US Treasuries was
purchased by foreigners and between 80% and 90% by central banks. For instance
central banks around the world, particularly in Asia, accumulated $490 billion in
dollar reserves in 2003, more than 90% of that year’s US current account deficit of
$530 billion. It was estimated that central banks increased their stock of dollar assets
by $465 billion in 2004. Analysts perceived that Asian central banks intervened to
prevent appreciation of their currencies against the dollar, so as to maintain the
competitiveness of their countries’ export sectors.

In contrast to Asian central banks, European central banks did not intervene in
currency markets. The result was an appreciation of the euro, the pound, and the
Swiss franc against the dollar. Between February 2002 and December 2004, in nominal
terms the euro appreciated 54%, the pound 36%, and the Swiss franc 48% against the
dollar. Depreciation of the US dollar against European currencies helped offset some of
the impact of accumulated current account deficits.

IESE Business School-University of Navarra 7

This document is authorized for use only in Gohar STEPANYAN's International Finance-1 course at EDHEC - Business School, from January 2017 to July 2017.
 IES204 BMW: Currency Hedging 2007

In the period 2005-2007, the US dollar exchange rate had favored companies exporting
from Europe. In 2007, after standing at US dollar 1.32 to the euro in January, it closed
the year 10% weaker, at 1.46 to the euro. The European Central Bank (ECB) continued
to pursue the tighter monetary policies initiated in 2006, increasing the reference
interest rate over the course of the year by a further 50 basis points to 4.00%. By the
middle of the year, the Bank of England (BoE) had also raised its reference interest rate
by a further 75 basis points to 5.75%, whereas the US Federal Reserve (Fed) kept its
rate at the same level. The second half of 2007 saw the sub-prime crisis in the US
mortgage market and a resulting confidence crisis on the financial markets. The BMW
Group has not been left unaffected by these developments. While the ECB decided not
to change the reference interest rate, the BoE reduced its rate by 25 basis points. The
Fed even reduced its rate by a total of 100 basis points. Despite these moves,
refinancing conditions deteriorated significantly as credit spreads widened sharply
across all sectors, thereby putting strain on the earnings of the financial services sector
worldwide.

The depreciation of the dollar, the lower interest rates, the weaker growth and the
USA's high current account deficit all suggest that the US dollar is likely to remain
weak in the near future.

Crisis in US Credit Market has Impact on World’s Stock Exchanges

The world’s stock markets were in general highly volatile in 2007. During the first half
of the year, market prices benefited sharply from good corporate figures. In the second
half, however, the markets were influenced by the credit crisis in the USA. The
weakness of the US dollar against the euro also had an increasingly adverse impact on
the share prices of European exporting companies. As the sub-prime crisis took hold in
the USA, some of the gains recorded by the world’s stock markets during the first half
of the year were lost. On the last day of trading in 2007, the leading German stock
index, the DAX, closed at 8,067.32 points, 22.3% ahead for the year, but short of its
record high level of 8,151 points in July 2007. The Dow Jones EURO STOXX 50 ended
the year with a gain of 6.8%. The Prime Automobile sector index performed very
strongly over the year, gaining 37.9% after closing at 785.54 points. BMW common
stock stood at euro 42.35 on the last day of trading, compared to a price of euro 43.51
one year earlier. With this 2.7% drop, BMW common stock was unable in 2007 to
repeat the gains made in preceding years. BMW preferred stock lost sharply in value,
finishing the year 16.6% lower at euro 36.30. The change in the price of preferred
stock reflects a high degree of market price speculation during 2006 and 2007.
According to media reports, one major German bank took up large-scale positions in
BMW preferred stock, resulting in a sharp market price. The bank unwound these
positions in 2007, thus significantly influencing the market price of BMW preferred
stock in 2007. See Exhibit 9.

BMW’s Hedging Strategy

This large impact of currency movements in BMW performance raised the issue of the
firm’s hedging strategy. Natural hedging, i.e. trying to match to the extent possible the

8 IESE Business School-University of Navarra

This document is authorized for use only in Gohar STEPANYAN's International Finance-1 course at EDHEC - Business School, from January 2017 to July 2017.
 BMW: Currency Hedging 2007 IES204

currency of its operating revenues to that of its operating expenses, was BMW’s
primary strategy. The central office in Munich issued guidelines, instructions and
consolidated risk figures globally while local treasury centers – which acted as a
support service rather than a profit center – provided operational risk management.
Every treasury center reviewed its exposure on a weekly basis and sent a report to
central control, where overall exposures were calculated.

BMW had an internally developed model, operational since 1994, which it used to plan
its FX hedging. The model showed the equilibrium rate for each currency, giving BMW
an indication of over- or under-valuation for major currencies. The results from that
model were reviewed every month and compared with a market average estimate of 84
banks. The hedging focus was long-term exposure (up to six years), with the goal
being an average hedge of around 36 months within a six-year timeframe. The specific
amount of exposure was dependent on the time period (with exposures for the coming
year more heavily hedged than those in year six) and the distance between the spot
rate and the equilibrium rate suggested by BMW’s internal model.

Nellen, head of interest and foreign exchange management, recalled in 2003 how they
operated.

“At the start of the euro, the exchange rate was €1.18 to the dollar, and the
equilibrium rate was around €1.15, so at that level we didn’t do very much. But
when the euro became very weak, for instance when it was at €0.82, we had a huge
cover on board. When it recovered, we did not buy as much cover. Of course, we
could never have complete cover over the 72-month period ahead, but we should be
aiming for a 36-month average or a 50% hedge of the full period.”

BMW continued to see a fair dollar at around 1.15 US$/€. In the Analysts´ Meeting
following the report of results for the Full Year 2007 BMW CEO Panke indicated that
BMW was almost fully hedged for 2008 for its dollar exposure.

BMW carried out its currency hedging by buying forward contracts or buying options,
three-years out, although at a declining scale. Only in the case of exchange rates
falling below this fair value range level would BMW hedge its currency exposure in the
long term and to a considerable extent. In the case of less favorable rates, currency
hedges would only be made to a lesser and more short-term extent (notice that the
dollar had not traded below the fair value range of 1.15 US$/€ to 1.17 US$/€ for quite
some time).

Once BMW determined fair-value the company opted for tactical hedges which are
1

mostly zero cost options, which implied a two-sided transaction, including two options
(long and short one of each instrument). The company received a premium on the sold
instrument and had to pay a premium on the bought side. Both option premiums
cancelled each other out which is why no cost occurred to the firm at inception. At
current spot rates BMW tried to leave upside open entering both options out of the money.
This meant that the firm was 100% exposed between the strike prices of the options it had
bought, and covered to the extent of options it had purchased, once the exchange rate
moved beyond these strike prices.

1 BMW´s fair value ranges from 1.15 to 1.17 according to different analysts

IESE Business School-University of Navarra 9

This document is authorized for use only in Gohar STEPANYAN's International Finance-1 course at EDHEC - Business School, from January 2017 to July 2017.
 IES204 BMW: Currency Hedging 2007

Even if BMW was hedged to even 100% it did not mean the company was immune
towards currency pressure in the respective year. In a scenario of a strengthening
dollar the company was benefiting only until the point where its sold option kicked in
and has therefore capped the upside. The company’s earnings suffered if currencies
weakened until the point where the hedged downside started to impact favorably. As
BMW did not want to lock in current rates the company was willing to “sacrifice”
some of the protection.

BMW also pursued a “cascade strategy” in its foreign currency hedging. This meant
that initial coverage was less than 100% of the estimated exposure. Coverage of the
remaining net exposure was then stepped up over the years. The actual business year’s
expected US dollar volumes had on average been covered by 90% to 100%. The
anticipated volumes of the first year thereafter had been secured by 66% to 75%, while
out of those of the second year after the actual one some 25% to 33% had been locked
in. This meant that out of the expected US dollar volumes for 2007, 33% had already
been secured in 2005, another 33% to 42% had been locked in during 2006 and the
rest was hedged in 2007. With this strategy, the closer a calendar year came to being
the actual one, the more hedged volumes had been stepped up via a roll-over process
for each respective year in an effort to raise the hedging shield. This strategy also
meant that the year’s spot rates remained determinants of the average transaction rate
as well, because they were being used to cover the rest of the net exposure not yet
secured.

10 IESE Business School-University of Navarra

This document is authorized for use only in Gohar STEPANYAN's International Finance-1 course at EDHEC - Business School, from January 2017 to July 2017.
 BMW: Currency Hedging 2007 IES204

Questions

1. How would you evaluate BMW´s transaction and operating exposure?

2. What do you think of BMW´s hedging strategy?

3. Taking into account the evolution of the US$/€ exchange rate during the last
few years do you consider a range of 1.15 US$/€ to 1.17 US$/€ to be an
appropriate equilibrium rate?

4. How would you define such an equilibrium exchange rate?

5. According to BMW´s net exposure and its hedging strategy, how big do you
think the impact of currency fluctuations is on profits and its stock market
value? How would you quantify it?

6. BMW likes to follow a natural hedging strategy for its operations. How can this
strategy help the firm in minimizing its US dollar exposure?

IESE Business School-University of Navarra 11

This document is authorized for use only in Gohar STEPANYAN's International Finance-1 course at EDHEC - Business School, from January 2017 to July 2017.
 IES204 BMW: Currency Hedging 2007

Exhibit 1
A. Revenues and Profits by Product

Breakeown by activities (€m) 2006 2007

Turnover 48,999 56,018
BMW Automotive 47,767 53,818
BMW Moto 1,265 1,228
Finance 11,079 13,940
Other -11,112 -12,968
Pre-tax underlying profit 4,124 3,873
BMW Automotive 3,012 3,232
BMW Moto 66 71
Finance 685 743
Other 361 -173
Operating margin on ordinary act 8.4% 6.9%
BMW Automotive 6.3% 6.0%
BMW Moto 5.2% 5.8%
Finance 6.2% 5.3%
Other -3.2% 1.3%

* This was primarily due to the fair value loss on the exchangeable bond option relating to the BMW Group investment in
Rolls-Royce plc, London.

B. Revenues by Region

Source: BMW annual report 2005.

12 IESE Business School-University of Navarra

This document is authorized for use only in Gohar STEPANYAN's International Finance-1 course at EDHEC - Business School, from January 2017 to July 2017.
 BMW: Currency Hedging 2007 IES204

Exhibit 2
Automobile Unit Sales Development by Product (% of total sales)

2001 2002 2003 2004 2005 2006 2007

2.8 13.6 16.0 15.3 15.1 13.7 14.9
Serie 1 3.2 11.3 11.1 11.1
Serie 3 59.0 53.1 47.8 37.2 32.7 37.0 37.0
Serie 5 21.4 16.3 16.8 19 17.2 16.9 15.4
Serie 6
Serie 7 3.6 5.1 5.2 3.9 3.8 3.7 3.0
X3 7.6 8.3 8.3 7.5
X5 9.1 9.5 9.6 8.7 7.7 5.5 8
Z3 3.9 1.9 0.3
Z4 0.4 4.3 3.2 2.2 2.3 1.9
Z8 0.2 0.1 0.1 ns ns ns
Units 905,657 1,057,344 1,104,916 1,208,732 1,327,992 1,373,970 1,500,678
Var. (%) 16.7 4.5 9.4 9.9 3.5 9.2

Source: BMW, Natixis Securities.

Moderate growth in 2008 sales (in units)

Product mix 2007 Chge 2008e Chge 2009e Chge 2010e Chge
7 Series
6 Series
5 Series
3 Series
3 Series compact

IESE Business School-University of Navarra 13

This document is authorized for use only in Gohar STEPANYAN's International Finance-1 course at EDHEC - Business School, from January 2017 to July 2017.
 IES204 BMW: Currency Hedging 2007

Exhibit 2 (continued)

BMW: New Launches

2007 2008 2009 2010 2011 2012
BMW Serie, 1, 3 doors Serie 1 cabriolet Serie 1 X5
Serie 1 coupé Z4 Serie 3
M3 coupé M3 sedan X6 hybride X3 Serie 6 sedan
Serie 61 M3 convertible Serie 7 hybride Serie 6 convertible
X6 Serie 5 PAS Serie 5 X6 restyle
Serie 7 X1 Gran Turismo

1
MINI Clubman Cabriolet Colorado One/Cooper

1
Restylage.

Source: Natixis Securities.

Exhibit 3
Balance Sheet, Income Statement and Key Operating Ratios
€ millions
Assets 12/31/07 12/31/06
Cash and Equivalents 4,352 3,370
Receivables Net 20,180 17,857
Inventories 7,349 6,794
Other Current Assets --- ---
Total Current Assets 32,375 28,543
Total Investments N/A N/A
Property, Plant & 28,121 24,927
Other Assets 6,060 5,646
Total Assets 88,277 78,302

Liabilities
Accounts Payable 3,516 3,624
ST Debt & Current 22,493 14,656
Income Taxes Payable 378 1,120
Other Current Liabilities 5,870 5,063
Total Current Liabilities 33,319 28,442
Long Term Debt 20,917 18,800
Other Liabilities 1,124 343
Total Liabilities 66,499 59,138
Shareholders' Equity
Minority Interest 11 4
Preferred Stock 34 34
Common Equity 21,733 19,126
Total Liabilities & 88,277 78,302
Shareholders' Equity

Source: BMW annual report 2005.

14 IESE Business School-University of Navarra

This document is authorized for use only in Gohar STEPANYAN's International Finance-1 course at EDHEC - Business School, from January 2017 to July 2017.
 BMW: Currency Hedging 2007 IES204

Exhibit 3 (continued)
Group Income Statement

Fuente: Source: BMW annual report 2005.

Exhibit 4
Raw material prices

IESE Business School-University of Navarra 15

This document is authorized for use only in Gohar STEPANYAN's International Finance-1 course at EDHEC - Business School, from January 2017 to July 2017.
 IES204 BMW: Currency Hedging 2007

Exhibit 5
A. BMW and Main Automobile Competitors: Key Statistics
Market Value Key Comparison:

EV/Sales (x) EV/EBITDA(x)

EV/EBITDA (x)
2005 2006 2007 2008E 2005 2006 2007 2008E
BMW 0.5 0.6 0.5 0.3 3.7 3.8 3.4 2.2
Daimler 0.3 0.4 0.4 0.3 2.4 2.8 2.4
VW 0.3 0.3 0.6 0.5 2.3 2.7 4.1 3.8
Porsche 1.2 1.1 0.8 1.0 4.5 3.3 1.1 2.0
Renault 0.2 0.3 0.4 0.2 2.0 3.1 3.6 1.6
Fiat 0.2 0.3 0.5 0.3 2.3 3.3 4.9 2.5
Source: Deutsche Bank.

B. Operating Performance Comparison

BMW vs Peer Group EBIT Margins %

9
8
7
6
5
4
3
2
1
0
2005 2006 2007 2008E

BMW VW Renault Fiat

Source: Deutsche Bank.

16 IESE Business School-University of Navarra

This document is authorized for use only in Gohar STEPANYAN's International Finance-1 course at EDHEC - Business School, from January 2017 to July 2017.
 BMW: Currency Hedging 2007 IES204

Exhibit 6
Evolution of Foreign Exchange

US$/€ / Exchange Rate (Jan. 2001-Sept. 2008)

1,60

1,50

1,40

1,30

1,20

1,10

1,00

0,90

0,80
01/01/00

01/06/00

01/11/00

01/04/01

01/09/01

01/02/02

01/07/02

01/12/02

01/05/03

01/10/03

01/03/04

01/08/04

01/01/05

01/06/05

01/11/05

01/04/06

01/09/06

01/02/07

01/07/07

01/12/07

01/05/08

IESE Business School-University of Navarra 17

This document is authorized for use only in Gohar STEPANYAN's International Finance-1 course at EDHEC - Business School, from January 2017 to July 2017.
 IES204 BMW: Currency Hedging 2007

Exhibit 7
BMW-Estimated Net Revenue Exposure Development (dollar based)

BMW (in millions of dollars) 2008E 2009E

North American sales volume 360,000 360,000
North American average price 36,000 36,000
North American revenue (USD) 12,960 12,960

North American production volume 140,000 160,000

North American avg. Production price 35,000 35,000
North American cost share per unit 0,65 0,65
North American variable costbase 3,185 36,40
North American fix cost base 2,500 2,500

Net revenue exposure in dollar 7,275 6,820

Source: Deutsche Bank, company.

18 IESE Business School-University of Navarra

This document is authorized for use only in Gohar STEPANYAN's International Finance-1 course at EDHEC - Business School, from January 2017 to July 2017.
 BMW: Currency Hedging 2007 IES204

Exhibit 8
BMW walkdown of 2007 EBIT (Automobiles)
US$/€ Exchange Rate (Jan 2001-Jan 2006)

2007-2010e results bridge

Volume/
mix/
market

Source : Datastream.

IESE Business School-University of Navarra 19

This document is authorized for use only in Gohar STEPANYAN's International Finance-1 course at EDHEC - Business School, from January 2017 to July 2017.
 IES204 BMW: Currency Hedging 2007

Exhibit 9
BMW’s Stock Compared to Some Stock Exchage Indices 1998-2007

20 IESE Business School-University of Navarra

This document is authorized for use only in Gohar STEPANYAN's International Finance-1 course at EDHEC - Business School, from January 2017 to July 2017.