All three of our companies AAPL, HPQ and Lenovo have
international operations. Due to the global nature of doing business computer
companies face a significant amount of exchange rate risk. By exchange rate
risk, we are referring to the risk associated with doing business globally. As
part of doing business internationally, companies expose themselves to exchange
rate risk. Fluctuations in foreign currency exchange rates, such as the
strengthening of the U.S. dollar against the Euro or the British pound or the
weakness of the Japanese yen, could adversely affect a company’s net revenue
growth in future periods. Furthermore, we also see that for companies engaged
in doing business globally currency variations adversely affects their margins
on sales of their products in countries outside of the United States and
margins on sales of products that include components obtained from suppliers
located outside of the United States. Considering all three of our firms
perform significant business globally, all of them are exposed to exchange rate
AAPL Exposure to Exchange Rate Risk
AAPL is based out of USA and operates in the following
geographical regions: Americas, Europe, Greater China, Japan and Rest of Asia
Pacific. In figure 4.1 we can see
that majority of AAPL’s sales takes place international. From its 10K we see
that AAPL’s $233 billion in net sales is contributed, 35 percent from domestic
and 65 percent by international sales. Because of significant exposure to
international operations, any fluctuation in exchange rate has substantial
affect to AAPL’s financial condition including gross margin.
AAPL has a strong global presence its suppliers are
located all over the world and AAPL sells its products all over the world as
well. Now due to the nature of its business, AAPL is impacted when a foreign
currency weakens relative to the US dollar and vice versa. Weakening of foreign
currency relative to U.S. dollar adversely affects its foreign
currency-denominated sales as a result AAPL may adjust International product
prices. On the contrary strengthening of foreign currency relative to U.S.
dollar implies AAPL benefits foreign currency-denominated sales. However it
also increases cost of product components denominated in those currencies, thus
adversely affecting gross margin.
Some of the major currencies that the company face
exchange rate risk on includes the Chinese Yuan (CNY), Japanese Yen (JPY),
European Dollar (EUR), Hong Kong Dollar (HKD), Taiwan Dollar (TWD) and
Australian Dollar (AUD). In figure 4.2,
we can see how the U.S. dollar stand against the CNY, JPY, EUR, HKD, TWD and
AUD. Other than EUR which stands stern at $1 for € 0.86 all other currencies
pose minimum risk considering their current exchange relative to US dollar.
From the 10K we learn that to offset its current risk,
AAPL enters into foreign currency forward and option contracts with financial
institutions to offset foreign exchange risks. AAPL uses US dollar as its
functional currency. In figure 4.3 we
can see the FX hedges AAPL enters into to offset its exposure to foreign
exchange risk. As we can see on the 10K, AAPL uses derivative instruments, such
as foreign currency forward and option contracts, to offset its exposures to
fluctuations in FX rates.
We also see that the company is a net receiver of
currencies other than the U.S. dollar, so to help protect gross margins from
fluctuations in foreign currency exchange rates, some of AAPL’s subsidiaries
whose functional currency is the U.S. dollar hedges portion of forecasted
foreign currency revenue. We also find that those subsidiaries whose functional
currency is not the U.S. dollar and who sell in local currencies, hedge portion
of forecasted inventory purchases which are not denominated in the
subsidiaries’ functional currencies. AAPL typically hedges portions of its
forecasted foreign currency exposure associated with revenue and inventory
purchases, typically for up to 12 months.
Furthermore from its 10K we identify that to help
protect any investment in a foreign operation from adverse changes in foreign
currency exchange rates, AAPL also enters into foreign currency forward and
option contracts to offset the changes in the carrying amounts of these
investments due to fluctuations in foreign currency exchange rates. Figure 4.4 shows the AAPL’s gains and losses
in futures contract.
HPQ Exposure to Exchange Rate Risk
From its 10K we can see that globally HPQ has
operations spread out in the following geographies: Americas, Europe and Asia pacific
and Japan. From figure 4.5 we see, 63
percent of its $48.24 billion in net sales comes from international operations,
domestic sales account for 37 percent of its net sales.
Similar to AAPL, HPQ benefits from a weaker U.S.
dollar and is also adversely affected by a stronger U.S. dollar relative to the
foreign currency. HPQ transacts business in approximately forty-four currencies
worldwide. However in its 10K it lists the following most significant foreign
currencies impacting HPQ’s operations: European Dollar (EUR), Great Britain
Pound (GBP), Chinese Yuan (CNY), Japanese Yen (JPY) and Indian Rupee (INR).
From figure 4.2 and figure 4.6 we gather that EUR which stands stern at $1 for €
GBP which stands at $1 for £0.76 are the only two currencies which pose a level
of risk to the operations of HPQ.
HPQ uses U.S. dollar as its functional currency. From
the 10K we see that HPQ is exposed to foreign currency exchange rate risk inherent
in its sales commitments, anticipated sales, anticipated purchases and assets
and liabilities denominated in currencies other than the U.S. dollar. HPQ use a
combination of forward contracts and at times, options designated as cash flow
hedges to protect against the foreign currency exchange rate risks inherent in
our forecasted net revenue and, to a lesser extent, cost of sales and
intercompany loans denominated in currencies other than the U.S. dollar. In
addition, when debt is denominated in a foreign currency, the company uses
swaps to exchange the foreign currency principal and interest obligations for
U.S. dollar-denominated amounts to manage the exposure to changes in foreign
currency exchange rates.
In figure 4.7
we see the forward and options contract entered by HPQ in 2016 and 2015 to
offset exchange rate risk. From the 10K document we understand that HPQ’s
foreign currency cash flow hedges mature generally within twelve months.
However, its hedges related to longer term procurement arrangements do extend
several years and forward contracts associated with intercompany loans extend
for the duration of the lease or loan term, which typically range from two to
Lenovo Exposure to Exchange Rate Risk
Most of Lenovo’s exchange rate risks arise primarily
with respect to United States dollar, Chinese Yuan (CNY), and European Dollar
(EUR). By going through the annual report we understand that Lenovo’s foreign
currency risk arises from future transactions, recognized assets and
liabilities and its net investment in foreign operations denominated in a
currency that is not the group companies’ functional currency. The company’s annual
report shows individual entities are measured (functional currency) using the
currency of the primary economic environment in which the entity operates. USD,
is Lenovo Group’s functional and presentation currency.
Lenovo’s financial risk management program established
as part of its ERM is responsible for managing Lenovo Group’s exposure to
exchange rate risk. Lenovo uses derivative financial instruments to hedge FX
risk exposures. We see that the company’s forward foreign exchange contracts
are either used: a) to hedge a percentage of future transactions (cash flow
hedges) or b) as fair value hedges for identified assets and liabilities. Figure 4.8 details the company’s
exposure at the balance sheet date to currency risk arising from recognized
assets or liabilities denominated in a currency other than the functional
currency of the entity to which they relate, except for the currency risk
between United States dollar and Hong Kong dollar given the two currencies are
under the linked exchange rate system.
Annual report highlights that the company has adopted
a consistent hedging policy for business transactions to reduce the risk of
currency fluctuation arising from daily operations. At March, 2017, the company
had commitments in the estimate of outstanding forward foreign exchange
contracts amounting to US$8,216 million which in 2016 was US $6,872 million.
Lenovo’s forward foreign exchange contracts are either used to hedge a
percentage of future transactions which are highly probable, or used as fair
value hedges for identified assets and liabilities. For presentation purposes,
the amounts of the exposure are shown in United States dollar, translated using
the spot rate at the balance sheet date. Differences resulting from the
translation of the financial statements of foreign operations into the Lenovo’s
presentation currency are excluded.
Analyzing Approaches towards Exchange Rate Risk
Having reviewed the exposures and responses of each
company, individually, we see that they all have some level of variability on
how they approach exchange rate risk. Both AAPL and HPQ has consistently used
forward contracts, interest rate swaps, and option contracts to offset foreign
currency risks. Lenovo on the other hand just uses forward foreign exchange
contracts to hedge its currency exchange risk. The recommendation we have for
Lenovo is to diversify its hedging portfolio, including introducing ‘Options’
derivative instrument to manage the company’s risk exposure should also be
We also need to keep in mind the causes of such
currency fluctuations. We see that majorly global economic events and
uncertainty causes currencies to fluctuate and that dominos to a currency
volatility contributing to variations in sales numbers of products and services
in impacted geographies. For example, in the event that one or more European
countries were to replace the euro with another currency, sales of companies
doing business in Europe would likely be adversely affected until stable
exchange rates are established. Few examples of current events which would
impact currency risk for organizations doing business worldwide are:
a) President Donald Trump’s tax reform opens prospect
of a stronger US Dollar heading into the end of 2017, this may adversely affect
foreign currency-denominated sales for AAPL, HPQ and Lenovo.
b) Continuous weakening of Chinese Yuan by Chinese
government, may negatively impact Lenovo Group’s revenue forecast, since close
to 30% of its revenue comes China2, and
Political unrest in Europe: Brexit – The UK prime minister’s decision to
trigger the Article 50 exit clause of the EU treaty gives the UK and the EU until
the end of March 2019 to reach an agreement.
crisis – could damage future business forecasts for AAPL, HPQ and Lenovo.
European market consists of nearly 20~25% of their revenue.