Banbury Impex (India) As November 2010 came to a close, CEO Aadesh Lapura of Banbury Impex Private Limited, a textile company in India, sat in his office in solitude looking over his company's financial statements. It looked like 2010 would close with a small growth in sales and a small drop in profits. Although Banbury’s profits were positive, the prospects of about 1.5% return on sales were simply not good enough moving forward. He now had two problems: a short-term prospective sale to a Turkish company, and a larger, long-term problem, of increasing his overall profitability. Lapura concluded that overall profitability – or lack thereof – was a result of two price forces. The first was the rapid rise in the price of cotton. A major cost driver in the textiles industry, cotton prices had risen dramatically in 2010. The second issue was clearly the rising value of the Indian rupee (INR) against the U.S. dollar (USD). Banbury’s sales were all invoiced in U.S. dollars, and the dollar was falling. Profit margins were down, and he needed to move quickly. Founded in 1997, Banbury Impex Private Ltd. was a family owned enterprise that manufactured and exported apparel fabrics. The company expected sales close to INR 25.6 crores or USD 5.4 million (a crore, cr, is a unit in the Indian numbering system equal to ten million) in 2010 as illustrated in Exhibit 1.

Banbury Impex (India) Sales were flat, operating income declining, and – to be honest – prospects bleak Exhibit 1 Banbury Impex Private Ltd—Sales and Income

Challenges Facing the Indian Textile Industry Rising raw material and labor costs. The chief raw materials used in textiles were cotton and other natural and poly based yarn. Erratic monsoons, coupled with increased exports of cotton in the recent years, had caused the price of cotton to rise dramatically. During the past 12 months cotton prices had increased more than 75%. A variety of government programs and restrictions had also contributed to a growing scarcity of skilled labor in the textile industry. Competition from China and other Asian countries. India and China account for the majority of global textile production. Due to low labor costs and strong government support and infrastructure, China had been able to stay ahead in competing with the BRIC (Brazil, Russia, India, and China) countries. As a consequence Chinese textile products were priced more competitively in the global market, and prevented Indian companies from pushing through any price increases. Indian companies were now suffering falling margins and losing orders to other countries. Much of the Indian low value market had already shifted to Bangladesh as costs there were 50% cheaper than in India. Appreciation of the Rupee. The rupee had grown increasingly volatile in recent years against the dollar, and over the past two years, appreciated by nearly 20%. This appreciation had made countries like Bangladesh and Vietnam more competitive on the global front. In early November the rupee had risen to INR 44/USD, the strongest in more than three years. It now hovered at 45. Further strengthening of the rupee against the dollar would most likely put many Indian textile companies out of business.

Banbury Impex (India) Exhibit 2 Curious Case of Rising Cotton Prices Cotton prices had been rising and rising throughout 2010. Exhibit 2 Curious Case of Rising Cotton Prices

Challenges Facing the Indian Textile Industry Cotton Futures. Lapura was considering the use of cotton futures, a practice some of his competitors were already using. A recent check of futures prices had provided him some data on what prices he may be able to lock in now for cotton in the coming year, in U.S. cents per pound: March 2011: 113.09; July 2011: 102.06/; October 2011: 95.03. Although futures would eliminate the risk of further increases in cotton prices, he was still afraid he would be locking in the price when at the top. Currency of Invoice. As an Indian textile exporter, Lapura had never really had any choice about the currency of invoice – it would be the U.S. dollar. But maybe times had changed? The dollar had been falling against the rupee for some time now, and as a result, the rupees generated from export sales were less and less. The problem was that as an exporter from what the world called an “emerging market,” his 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!

Challenges Facing the Indian Textile Industry Exhibit 3 Indian Rupee/U.S. Dollar Spot Rate

The Turkish Sale Exhibit 4 Forward Rate Quotes Turkish Exposure. Lapura’s immediate problem was a $250,000 textile sale he had just made to a Turkish customer. The contract allowed him to change the currency of invoice from the Turkish lira to the dollar or euro if he wished, but he had to decide by close of business today. Expected settlement on the invoice was January 30, 2011. But regardless of which currency he chose (the rupee not being one of the choices), he still had to decide how to hedge it. Forward Rates. Lapura had collected a variety of forward rates from his local bank for the dollar, euro, and Turkish lira, as listed in Exhibit 4. He eyed the dollar quotes the closest. The forwards would lock him into a rupee rate which was slightly better than the current spot rate. Of course if the forwards were considered indicators of likely rate movement, they did indicate what he had long hoped for – a rise in the dollar. Exhibit 4 Forward Rate Quotes

The Turkish Sale Exhibit 5 Currency Option Quotes on the USD Money Market Hedge. He had also considered some form of money market hedge – borrowing Turkish lira against the receivable. Although he had been selling in Turkey for over five years, he had never borrowed there, and only had one bank relationship in Ankara. If he provided sales history to the Turkish bank, he may be able to use his $250,000 receivable as collateral. Domestic loan rates in Turkey for companies with similar credit quality were about 14% according to his bankers. But his bankers also told him that as a small foreign business, the Turkish market would charge him an additional 300 basis point credit spread. But if he did indeed get the money sooner rather than later, domestic Indian deposit rates were averaging a healthy 10.4%. Currency options had recently become a hedging alternative in India. The National Stock Exchange of India in Mumbai had opened a currency options market in October 2010. With no experience with options, Lapura wondered if an option would provide better protection than a forward contract. The options market, at least for now, was limited to INR/USD options. Although Mr. Lapura could see the upside potential that an options contract might provide, he wondered how much the contract would hurt his slim margins if he had to exercise his contract. Exhibit 5 Currency Option Quotes on the USD

Decision Time Aadesh Lapura picked up his notes and knew it was time to call a family meeting. Times were tough and the family's livelihood was being threatened. Two things needed to be sorted out and quickly. With the last major sale of 2010 on the books – the Turkish sale, he knew he needed to protect the value of this sale from currency losses. Secondly, he needed to find a sustainable path to protecting the business over the long term. With India's continued economic growth, many analysts are forecasting a stronger Indian Rupee vs USD exchange rate into the foreseeable future. Competition was fierce. Lapura wondered how much longer his Indian operations – the livelihood of the family – would be profitable.

Banbury Impex (India): Discussion Questions Which factor do you think is more threatening to Banbury’s profitability, cotton prices or the rising value of the rupee? Do you believe Lapura should hedge his cotton costs with cotton futures? What would you recommend? Which currency of invoice do you think Lapura should choose for the Turkish sale? What recommendation would you make in terms of hedging the Turkish sale receipts?

Banbury Impex (India): Case Questions Which factor do you think is more threatening to Banbury’s profitability, cotton prices or the rising value of the rupee? Rising cotton prices, particularly given their near-extreme one-way movement, are likely to be a more fundamental problem for Banbury’s profitability. The Indian government, well aware of how devastating a continual appreciation of the rupee will be for export businesses of all kinds, will likely take sufficient action to keep the rupee from continuing to appreciate. The Indian government, however, cannot take protective actions on cotton prices; cotton is a global commodity and its price is set on the global market.

Banbury Impex (India): Case Questions Do you believe Lapura should hedge his cotton costs with cotton futures? What would you recommend? The case does not provide sufficient information to evaluate the prospects, quantitatively, of using cotton futures. However, as with all forward and futures markets, futures rates are based on current spot rates. If Lapura believes that cotton prices have risen as high as they are likely to go, using futures would likely add needlessly to cost. If, however, cotton prices may continue to rise – and there is little to indicate that they won’t, some type of hedge such as cotton futures may be extremely effective in principle in controlling his major input costs going forward.

Banbury Impex (India): Case Questions Which currency of invoice do you think Lapura should choose for the Turkish sale? -- and simultaneously -- What recommendation would you make in terms of hedging the Turkish sale receipts? Choosing the currency of invoice is important if Lapura has a view on the direction of exchange rate movements, or the hedging alternative which he intends to use yields higher Indian rupee (INR) results with a specific currency/hedge combination. Lapura has no directional view on the various currencies included, though he does fear over a continually rising rupee. Unfortunately, he is an Indian business and ultimately the proceeds need to be realized in Indian rupees. The spreadsheet solution indicates that invoicing in U.S. dollars and covering with a60-day forward contract yields the highest returns. Note: Since cotton prices are in U.S. dollars, a matching currency inflow in U.S. dollars would be an added natural or operating hedge.