The negatively affected by: Liquidity, Credit deterioration, financial

The risk associated with doing business with another
party who may be unable to fulfill its side of the obligation and will
ultimately default is known as Counterparty risk. In exploring our three
companies we will soon see why counterparty risk can be a big risk for them. Our
three companies are large in capacity and the counterparty risk that they face
revolves around: trade, vendor non-trade receivables and long-term prepayments.

AAPL Counterparty Risk

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Although AAPL has not realized any significant losses
on its cash, cash equivalents and marketable securities till date, future
fluctuations in their value could result in significant losses. From the
company’s 10K we see that the company’s credit ratings and pricing of its
investments can be negatively affected by: Liquidity, Credit deterioration, financial
results, Economic risk, Political risk and Sovereign risk. The company’s 10K
shows that AAPL’s exposure to credit risk on its trade receivables is higher in
certain international markets and its ability to mitigate such risks is
limited. The company is also exposed to credit risk on its trade accounts
receivable and vendor non-trade receivables related to long-term supply
agreements. The company’s 10K shows that trade receivables as of September
2017, in which AAPL had two customers that individually represented 10% or more
of total trade receivables, each of which accounted for 10%. On the vendor non-trade
receivables side on September 2017, AAPL had three vendors, which accounted for
42%, 19% and 10% showing that the vendors individually represented 10% or more
of total vendor non-trade receivables.

In terms of managing the counterparty risk the
company’s 10K confirms that AAPL has procedures to monitor and limit the
company’s exposure to credit risk on its trade and vendor non-trade
receivables, as well as long-term prepayments. AAPL requires collateral in
certain instances from its vendors to limit the credit risk. The 10K also shows
that the company enters into master netting arrangements, which are designed to
reduce credit risk by permitting net settlement of transactions with the same
counterparty. Now let’s understand what a master netting arrangement is. A
master netting arrangement is a master contract between two counterparties that
have multiple derivative contracts opened with each other. In an event of
default or on termination of any one contact, the master agreement provides for
the net settlement of all contracts which are opened between the two
counterparties, as well as cash collateral, through a single payment, in a
single currency. We also see that the net cash collateral received by AAPL
pertaining to derivative instruments under its collateral security arrangements
as of September, 2017 and September, 2016 was $35 million and $163 million,
respectively. Further the 10K also provides information that AAPL limits the
company’s credit risk on trade receivables with credit insurance for certain
customers, requiring third-party financing, loans or leases to support credit
exposure.

HPQ Counterparty Risk

Next we discuss the counterpart risk of HPQ. The
company’s 10K shows that instruments that potentially subject HPQ to
significant concentrations of credit risk consist principally of cash and cash
equivalents, investments, receivables from trade customers and contract
manufacturers and derivatives. HPQ maintains cash and cash equivalents,
investments, derivatives and certain other financial instruments with various
financial institutions. The company’s financial institutions are located in
different geographic regions, and HPQ’s policy is designed to limit exposure
from any particular institution. The company’s 10K shows that, due to
technology, availability, price, quality or other considerations HPQ obtains
significant number of components from single source suppliers. The factors that
could adversely affect HPQ’s net revenue and gross margins include: a) the loss
of a single source supplier, b) deterioration of the company’s relationship
with a single source supplier, or c) any unilateral modification to the
contractual terms under which HP is supplied components by a single source
supplier. HPQ sells a significant portion of its products through third-party
distributors and resellers and, as a result, the company maintains individually
significant receivable balances with these parties. Furthermore if the
financial condition or operations of any of HPQ’s distributors’ or resellers’
or single source suppliers’ aggregated business deteriorates substantially, the
company’s operating results could be adversely affected.

Now we see the measures HPQ has in place to offset its
counterparty risks. The company’s 10K shows that HPQ performs periodic
evaluations of its credit standing with financial institutions. The company
also utilizes derivative contracts to protect against interest rate exposures.
HPQ’s ten largest distributor and reseller receivable balances, which were
concentrated primarily in North America and Europe, collectively represented
approximately 34% and 42% of gross accounts receivable as of October, 2016 and
2015, respectively. The 10K confirms that none of HPQ’s customer accounts
totals more than 10% of gross accounts receivable in the years 2016 or 2015.
The company performs ongoing credit evaluations of its financial condition of
its third-party distributors, resellers and other customers and in certain
circumstances, may also require collateral, such as letters of credit and bank
guarantees. The company’s credit risk associated with receivables is mitigated,
by the amount HPQ owes to its outsourced manufacturers, since the company has
the legal right to offset its payables to the outsourced manufacturers against
these receivables.

Lenovo Counterparty Risk

Lastly we review the counterpart risk exposure for
Lenovo. From its annual report we see that Lenovo has no significant
concentration of customer credit risk. The company manages its credit risk at a
group level. For Lenovo credit risk arises from: a) cash and cash equivalents,                b) derivative financial
instruments and c) deposits with banks and financial institutions, credit
exposures to customers, including outstanding receivables and committed
transactions. From the annual report we find that the company’s exposure to
credit risk for 2016 and 2015 are $2,951 and $2,079 million dollars
respectively.

Now let’s explore the measure that Lenovo has to
manage its counterparty risk. From Lenovo’s annual report we find that for
banks and other financial institutions, the company controls its credit risk
through monitoring their credit rating and setting approved counterparty credit
limits that are regularly reviewed. Furthermore the company has a credit policy
in place and exposures to these credit risks are monitored on an ongoing basis.
From the annual report we find that as of March, 2016, the company’s
receivables in the amount of US$2 million were held as collateral for
short-term loans.

Analyzing Approaches on Counterparty Risks

On reviewing the approaches each of the company’s tool
in offsetting their counterparty risks, Collateralization single handedly stands
out as the most common mechanism they have used to manage the company’s
exposure to Counterparty risk. Now let’s get a little deep as to what
Collateralization is. Businesses can use collateralization for debt offerings.
Collateralization of assets gives lenders sufficient level of reassurance
against default risk. When company’s issue bonds, they may go into details as
to the specific asset, such as equipment and/or property that is being pledged
for the repayment of the bond offering in event of default. However we also
need to be aware of the fact that with the increased level of security offered
to a bondholder typically means that the coupon rate offered on the bond will
be lower as well.

Now, let’s revisit both AAPL and HPQ’s credit profile.
Figure 6.1 shows the credit rating of
AAPL for the past five years. We see that over the past five years the company
has maintained a constant credit rating which rates it as Investment Grade with
very low credit risk. Further figure 6.3
shows the financial ratios of AAPL which further provides evidence of its
strong credit rating. For HPQ we see in figure
6.2 that the company’s credit rating over the past five years is kept at a
contestant level by Standard and Fitch, however Moody’s have lowered
it by a notch. Though overall the credit rating of HPQ also falls within the Investment
Grade spectrum, but with a moderate credit risk. Figure 6.4 shows the financial ratios of HPQ which provides the
full evidence as to why the company is rated Investment Grade by all the three
credit rating agencies. Further to access strong credit worthiness of our three
company’s let’s see figure 6.5, which
shows the debt profile of out three companies. When we look closely at the way
the debt is spread we see that for all of our companies’ the short term debt is
much less that the long term debt spread. This further increases the credit
quality of our companies as it shows that all three of our companies have the
needed capital to meet their short term obligations and have majority of their
debt for long term.