All three of our companies AAPL, HPQ and Lenovo haveinternational operations.
Due to the global nature of doing business computercompanies face a significant amount of exchange rate risk. By exchange raterisk, we are referring to the risk associated with doing business globally. Aspart of doing business internationally, companies expose themselves to exchangerate risk. Fluctuations in foreign currency exchange rates, such as thestrengthening of the U.S. dollar against the Euro or the British pound or theweakness of the Japanese yen, could adversely affect a company’s net revenuegrowth in future periods.
Furthermore, we also see that for companies engagedin doing business globally currency variations adversely affects their marginson sales of their products in countries outside of the United States andmargins on sales of products that include components obtained from supplierslocated outside of the United States. Considering all three of our firmsperform significant business globally, all of them are exposed to exchange raterisk.AAPL Exposure to Exchange Rate RiskAAPL is based out of USA and operates in the followinggeographical regions: Americas, Europe, Greater China, Japan and Rest of AsiaPacific. In figure 4.1 we can seethat majority of AAPL’s sales takes place international. From its 10K we seethat AAPL’s $233 billion in net sales is contributed, 35 percent from domesticand 65 percent by international sales.
Because of significant exposure tointernational operations, any fluctuation in exchange rate has substantialaffect to AAPL’s financial condition including gross margin. AAPL has a strong global presence its suppliers arelocated all over the world and AAPL sells its products all over the world aswell. Now due to the nature of its business, AAPL is impacted when a foreigncurrency weakens relative to the US dollar and vice versa. Weakening of foreigncurrency relative to U.S. dollar adversely affects its foreigncurrency-denominated sales as a result AAPL may adjust International productprices. On the contrary strengthening of foreign currency relative to U.S.
dollar implies AAPL benefits foreign currency-denominated sales. However italso increases cost of product components denominated in those currencies, thusadversely affecting gross margin. Some of the major currencies that the company faceexchange rate risk on includes the Chinese Yuan (CNY), Japanese Yen (JPY),European Dollar (EUR), Hong Kong Dollar (HKD), Taiwan Dollar (TWD) andAustralian Dollar (AUD). In figure 4.2,we can see how the U.
S. dollar stand against the CNY, JPY, EUR, HKD, TWD andAUD. Other than EUR which stands stern at $1 for € 0.86 all other currenciespose 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 financialinstitutions to offset foreign exchange risks.
AAPL uses US dollar as itsfunctional currency. In figure 4.3 wecan see the FX hedges AAPL enters into to offset its exposure to foreignexchange risk. As we can see on the 10K, AAPL uses derivative instruments, suchas foreign currency forward and option contracts, to offset its exposures tofluctuations in FX rates. We also see that the company is a net receiver ofcurrencies other than the U.S. dollar, so to help protect gross margins fromfluctuations in foreign currency exchange rates, some of AAPL’s subsidiarieswhose functional currency is the U.
S. dollar hedges portion of forecastedforeign currency revenue. We also find that those subsidiaries whose functionalcurrency is not the U.S. dollar and who sell in local currencies, hedge portionof forecasted inventory purchases which are not denominated in thesubsidiaries’ functional currencies. AAPL typically hedges portions of itsforecasted foreign currency exposure associated with revenue and inventorypurchases, typically for up to 12 months. Furthermore from its 10K we identify that to helpprotect any investment in a foreign operation from adverse changes in foreigncurrency exchange rates, AAPL also enters into foreign currency forward andoption contracts to offset the changes in the carrying amounts of theseinvestments due to fluctuations in foreign currency exchange rates.
Figure 4.4 shows the AAPL’s gains and lossesin futures contract.HPQ Exposure to Exchange Rate RiskFrom its 10K we can see that globally HPQ hasoperations spread out in the following geographies: Americas, Europe and Asia pacificand Japan. From figure 4.5 we see, 63percent 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 theforeign currency. HPQ transacts business in approximately forty-four currenciesworldwide. However in its 10K it lists the following most significant foreigncurrencies impacting HPQ’s operations: European Dollar (EUR), Great BritainPound (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 €0.861 andGBP which stands at $1 for £0.76 are the only two currencies which pose a levelof risk to the operations of HPQ.
HPQ uses U.S. dollar as its functional currency. Fromthe 10K we see that HPQ is exposed to foreign currency exchange rate risk inherentin its sales commitments, anticipated sales, anticipated purchases and assetsand liabilities denominated in currencies other than the U.S.
dollar. HPQ use acombination of forward contracts and at times, options designated as cash flowhedges to protect against the foreign currency exchange rate risks inherent inour forecasted net revenue and, to a lesser extent, cost of sales andintercompany loans denominated in currencies other than the U.S. dollar. Inaddition, when debt is denominated in a foreign currency, the company usesswaps to exchange the foreign currency principal and interest obligations forU.
S. dollar-denominated amounts to manage the exposure to changes in foreigncurrency exchange rates. In figure 4.7we see the forward and options contract entered by HPQ in 2016 and 2015 tooffset exchange rate risk. From the 10K document we understand that HPQ’sforeign currency cash flow hedges mature generally within twelve months.However, its hedges related to longer term procurement arrangements do extendseveral years and forward contracts associated with intercompany loans extendfor the duration of the lease or loan term, which typically range from two tofive years.
Lenovo Exposure to Exchange Rate RiskMost of Lenovo’s exchange rate risks arise primarilywith respect to United States dollar, Chinese Yuan (CNY), and European Dollar(EUR). By going through the annual report we understand that Lenovo’s foreigncurrency risk arises from future transactions, recognized assets andliabilities and its net investment in foreign operations denominated in acurrency that is not the group companies’ functional currency. The company’s annualreport shows individual entities are measured (functional currency) using thecurrency 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 establishedas part of its ERM is responsible for managing Lenovo Group’s exposure toexchange rate risk. Lenovo uses derivative financial instruments to hedge FXrisk exposures.
We see that the company’s forward foreign exchange contractsare either used: a) to hedge a percentage of future transactions (cash flowhedges) or b) as fair value hedges for identified assets and liabilities. Figure 4.8 details the company’sexposure at the balance sheet date to currency risk arising from recognizedassets or liabilities denominated in a currency other than the functionalcurrency of the entity to which they relate, except for the currency riskbetween United States dollar and Hong Kong dollar given the two currencies areunder the linked exchange rate system.Annual report highlights that the company has adopteda consistent hedging policy for business transactions to reduce the risk ofcurrency fluctuation arising from daily operations. At March, 2017, the companyhad commitments in the estimate of outstanding forward foreign exchangecontracts 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 apercentage of future transactions which are highly probable, or used as fairvalue hedges for identified assets and liabilities. For presentation purposes,the amounts of the exposure are shown in United States dollar, translated usingthe spot rate at the balance sheet date. Differences resulting from thetranslation of the financial statements of foreign operations into the Lenovo’spresentation currency are excluded.
Analyzing Approaches towards Exchange Rate RiskHaving reviewed the exposures and responses of eachcompany, individually, we see that they all have some level of variability onhow they approach exchange rate risk. Both AAPL and HPQ has consistently usedforward contracts, interest rate swaps, and option contracts to offset foreigncurrency risks. Lenovo on the other hand just uses forward foreign exchangecontracts to hedge its currency exchange risk. The recommendation we have forLenovo is to diversify its hedging portfolio, including introducing ‘Options’derivative instrument to manage the company’s risk exposure should also belooked into.We also need to keep in mind the causes of suchcurrency fluctuations.
We see that majorly global economic events anduncertainty causes currencies to fluctuate and that dominos to a currencyvolatility contributing to variations in sales numbers of products and servicesin impacted geographies. For example, in the event that one or more Europeancountries were to replace the euro with another currency, sales of companiesdoing business in Europe would likely be adversely affected until stableexchange rates are established. Few examples of current events which wouldimpact currency risk for organizations doing business worldwide are: a) President Donald Trump’s tax reform opens prospectof a stronger US Dollar heading into the end of 2017, this may adversely affectforeign currency-denominated sales for AAPL, HPQ and Lenovo.b) Continuous weakening of Chinese Yuan by Chinesegovernment, may negatively impact Lenovo Group’s revenue forecast, since closeto 30% of its revenue comes China2, andlastly, c)Political unrest in Europe: Brexit – The UK prime minister’s decision totrigger the Article 50 exit clause of the EU treaty gives the UK and the EU untilthe end of March 2019 to reach an agreement. Cataloniacrisis – could damage future business forecasts for AAPL, HPQ and Lenovo.European market consists of nearly 20~25% of their revenue.