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Banbury Impex Private Limited

The CEO of Banbury Impex Private Limited, a textile company in India, is looking over his companys financial statements, thought that even though the profits were positive, the prospects of about 15% return on sales were simply not good enough. Banbury was a family-owned enterprise that manufactured and exported apparel fabrics. He now had two problems; negotiating a short-term prospective sale to a Turkish company and increasing his overall profitability, which was a larger, long-term problem.

The CEO concluded that overall reduction in profitability was a result of two price forces. The first was the rapid rise in the price of cotton. A major cost driver in the textile industry, cotton prices had risen dramatically. The second issue was the rising value of the Indian rupee against the U.S. dollar. Banburys sales were all invoiced in the U.S. dollar, and the dollar was falling. Profit margins were down and he needed to move quickly. The company expected sales close to USD 5.4 million.in 2020. But as sales were flat, operating income was declining.

Banburys sales were nearly all exported mainly to the Middle East (50%), South America (30%) and Europe (10%). Banburys products included a range of blended woven fabrics made from viscose, cotton and wool. The company operated two weaving units based in India. Cash flows had remained relatively predictable as the company had managed foreign exchange risks by using forward contracts. Choosing to invoice all international sales in USD helped provide further stability in mitigating raw material cost as international cotton process were priced in USD. All things considered, Bunburys profit projections for 2021 were looking low.

The Indian textile has been a major contributor to the Indian GDP over the past several years. The textile industry was both capital and labor intensive as well as highly regulated. Companies operated on small margin in a highly competitive marketplace. Challenges faced by the Indian textile industry included the following;

- Due to erratic monsoons over the past 12 months, cotton prices had increased more than 75%.

- India and China account for the majority of global textile production. Due to low labor cost and strong government support and infrastructure, China had been able to stay ahead in competing with the BRIC countries. As a result, the Chinese textile products were priced more competitively in the global market and prevented Indian companies from pushing through any price increase.

- The rupee had grown increasingly volatile against the dollar and over the past two years, appreciated by nearly 20%. It was now around 45 rupee/USD. The appreciation has made countries like Bangladesh and Vietnam more competitive in the global font. Further strengthening of the rupee against the dollar would most likely put many Indian textile companies out of business.

As an Indian textile exporter, the company had never had choice about the currency of invoice it would be the U.S. dollars. But maybe time has changed. The dollar has been falling against the rupee for some time now and as a result the rupee generated from export sales were less and less. The problem was that as an exporter from the emerging market, the hard currency choices were the U.S. dollar, the European euro, and the Japanese yen. And the rupee had been strengthening against all of them resulting in lower revenue from export sales.

The companys immediate problem was $250,000 textile sale made to a Turkish customer at the end of April, 2020. The contract allowed the company to change the currency of invoice from the Turkish lira to the dollar or Euro. Expected settlement on the invoice was at the end of June, but regardless of which currency the company chose, the rupee is not being one of the choices; it still had exposure to risk.

The company had collected a variety of forward rates from the local bank for the dollar, euro and Turkish lira as listed below. The forwards would lock the company into a rupee rate, which was better than the current spot rate.

Of course, if the forwards were considered indicators of likely rate movement, they indicated a rise in the dollar. The CEO also considered some form of money market hedge borrowing in Turkish lira against the receivable. Domestic loan rates in Turkey for companies with similar credit quality were about 14% according to the bankers. But, as a small foreign business, the Turkish market would charge Banbury an additional 0.3 percent. Indian deposits rates were averaging 10.4 percent per annum.

The currency options had recently become a hedging alternative in India. The option market was limited to INR (Indian Rupee)/USD options.

Case Questions:

1.1 What are the transaction and operational exposure of Banbury Impex Private Limited?

1.2 What are the contractual hedging strategies available to Banbury to reduce the foreign exchange risk exposure and which strategy would you recommend?

Currency Spot Forward Forward Forward 30 days 60 days 90 days 45.8300 46.12 46.70 46.11 Indian Rupee per U.S. Dollar Indian Rupee per Euro 60.9611 61.70 61.90 62.20 Japanese Yen per Rupee 1.8250 1.81 1.81 1.81 30.7192 30.96 30.95 30.87 Indian Rupee per Turkish lira Turkish lira per U.S. dollar 1.4793 1.49 1.48 1.48 Currency Option Quotes on the USD: Strike Price (Rupee/USD) Put Premium Call Premium 44.00 0.005 1.890 45.25 0.035 0.440 Quotes for 60 day maturity USD1000 per contract (The case is adapted from Thunderbird School of Global Management, 2010) Currency Spot Forward Forward Forward 30 days 60 days 90 days 45.8300 46.12 46.70 46.11 Indian Rupee per U.S. Dollar Indian Rupee per Euro 60.9611 61.70 61.90 62.20 Japanese Yen per Rupee 1.8250 1.81 1.81 1.81 30.7192 30.96 30.95 30.87 Indian Rupee per Turkish lira Turkish lira per U.S. dollar 1.4793 1.49 1.48 1.48 Currency Option Quotes on the USD: Strike Price (Rupee/USD) Put Premium Call Premium 44.00 0.005 1.890 45.25 0.035 0.440 Quotes for 60 day maturity USD1000 per contract (The case is adapted from Thunderbird School of Global Management, 2010)

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